Refinancing a mortgage

Many homeowners can benefit from a refi

As of August 18, the interest rate on a 30-year fixed-rate mortgage was averaging 5.13%, according to Freddie Mac — almost double rates only a year ago.¹ And with mortgage rates on the rise, many Americans are wondering about the process of refinancing. How soon can you do it? How long does it take? How much does it cost, and is it worth it?

Read on for answers to five common questions about refinancing a mortgage.

1. Is a refi worth it?

Lowering your rate by at least three quarters of a percentage point (6.25% to 5.5%, for example) is generally considered the minimum difference between current and prospective mortgage rates to make a refi worth the expense.²

Be aware that all mortgages front load interest payments, meaning the percentage of your monthly payment that goes to interest is much higher at the beginning of a loan. In that sense, a refinance means you’ll be paying again for interest that you already paid on your first mortgage. This helps explain why your new, refinanced interest rate needs to be substantially lower in order for you to come out ahead.

One test to determine if a refi is worth it for you is to divide your total closing costs by the amount you’ll save on monthly payments. (Both those numbers will be in the loan estimate provided by the bank). That’s your break-even point — the number of months it will take to recoup your closing costs.

There is no “right” break-even point, because everyone has different goals and finances. In general, though, if you’re planning to stay in your home for many years, you may be willing to accept a later break-even point.

You can also use an online mortgage refinance calculator to help you make a decision.

2. Should I refinance my mortgage?

Here are some of the most common reasons to refinance:

• To reduce your monthly payment. The main reason people refinance is to reduce their monthly payment thanks to that lower interest rate, and assuming they’ve built up equity, elimination of any private mortgage insurance (PMI). But be careful: If you’ve already paid 10 years on a 30-year mortgage, taking out a new 30-year mortgage means you’re essentially signing on to a total of 40 years of mortgage payments.
• To shorten your term. Other people take advantage of the rate savings to shorten their term — often by switching to a 15-year loan. The monthly payment in that case could actually be higher, but if you’re earning more money and want full homeownership sooner, it could be a good deal.
• To change the type of mortgage. You may want to change the type of your mortgage — say, from an adjustable-rate (ARM) that’s about to go up (often after the first five years) to a new fixed rate. Some people planning to move in a few years do the opposite, switching from fixed-rate to an ARM with a low introductory rate.
• To take out cash. Some homeowners want to take out cash from their home’s equity. This cash might can be used for big-ticket expenses like a renovation project or even to consolidate credit-card or student-loan debt at lower, and potentially tax-deductible, interest. The downside is that your formerly unsecured debt will now be secured against your home, which could be taken from you if you default.

3. How soon after taking out your original mortgage can you refinance?

Usually, the answer works out to about six months. However, right now you’d need a fixed-rate mortgage dating back to around 2008, the last time rates were a point or so higher than now, to make a refi worth it.

4. How long does it take to refinance a mortgage?

A refi takes the same time as an original mortgage — around 30-45 days. The bank will require an appraisal, inspection, title search and other paperwork. During this time, you can usually choose to lock in your rate.

5. How much does it cost to refinance a mortgage?

As with your original mortgage, you’ll pay closing costs and potentially origination points, which are percentages of the loan you pay upfront to reduce the interest rate. Expect a refi to cost anywhere from 3% to 6% of the total loan amount. Note that your original mortgage might have a prepayment penalty, which you must also factor in.

You’ll also need good credit — ideally a score of 700 or higher — and generally at least 20% equity in your home. It also helps to have a debt-to-income ratio (DTI) — the amount of your total monthly debt payments (including the new mortgage) as a percentage of your gross monthly income — no higher than 36%. These factors aren’t written in stone, but they will affect your rate.

Special types of refis

A jumbo mortgage is one that exceeds the so-called conforming limits set by the federal government — in 2022, from $647,200 to $970,800 depending on location³ — and thus is not underwritten by Freddie Mac or other agencies. When refinancing a jumbo mortgage — expect the process to take a few months — since the bank, as the sole underwriter, will want lots of documentation on your income and resources.

You can also refinance a second mortgage, such as a home equity loan or line of credit, often by rolling it into a new refinanced loan with your primary mortgage — so long as you still retain at least 20% equity in your home. If you want to refinance your primary mortgage but keep your second mortgage separate, you’ll need to ask the lender of the second mortgage to subordinate their loan to the refi.

The bottom line on refinancing

Don’t let rising mortgage rates keep you awake at night. Most lenders have already factored in the rate increases expected by the Federal Reserve, and chances are good that mortgage rates won’t shift drastically in the coming months.

Instead of rushing to refinance, shop around to several different lenders in order to get the best rate. Once you make sure a refinance is worth the time and expense, you can sign on the bottom line calmly and with confidence.

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