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Katie OrmsbyMortgage Refinance Expert

Katie enjoys helping readers make sense of Mortgage Refinance options. She's previously written business and shopping features for The Seattle Times and Seattle Met magazine. She has a degree in journalism and political science from the University of Washington.

How Mortgage Refinance Loans Work

With mortgage rates sitting near all-time lows, it’s a great time to consider refinancing your existing mortgage. Whether you’re looking for a lower monthly payment or you’re in need of extra cash for a home repair, mortgage refinancing options can meet your specific needs and help to save you money.

There are several types of mortgage refinancing options, but it can be hard to determine the best route. Once you empower yourself with information, you’ll be ready to submit your paperwork and reap all the benefits that today’s refinancing rates offer.

What Is Mortgage Refinancing?

Mortgage refinancing is when you replace your existing mortgage with a new mortgage. Refinancing allows you to renegotiate the terms of your original mortgage and often lowers your monthly payment or reduces the length of time you’ve committed to paying off your home.

Mortgage refinance rates remain lower than we’ve seen them. So, if you were to trade your old mortgage in for refinanced terms, then you could see significant savings over time. Ultimately, refinancing your mortgage can give you a better handle on your finances.

Pros and Cons of Refinancing Your Mortgage

Pros
Cons
Lock in a lower interest rate
Closing costs can be high
Switch to a predictable fixed rate
Can be a lengthy process
Chance to get a lump sum of cash
Cash-out refi reduces your equity

What Types of Mortgage Refinance Loans Are There?

When you’re considering refinancing your mortgage, it’s important to know the difference between the types of home refinance loans. The two most popular types are rate-and-term refinance and cash-out refinance loans.

Rate-and-term refinance loan

For those who want to lower their payments or secure a low fixed interest rate, a rate-and-term refinance loan can be a great option. This type of refinance loan won’t change the size of your mortgage, but it could give you better terms. If you shorten your term, you could build your equity faster and pay the loan off faster. On the other hand, lengthening your term can result in lower monthly payments. Rate-and-term loans are usually available with 15- or 30-year repayment terms.

Cash-out refinance loan

While rate-and-term refinance loans don’t touch the equity you’ve built in your home, cash-out refinance loans do. With this option, homeowners replace their current mortgage with a bigger mortgage. Then, homeowners cash out the difference between the two mortgages. So, cash-out refinance is not only a chance to get a new rate, but it’s also an opportunity to get a lump sum of cash. Homeowners can use that money to cover home improvements, pay off high-interest debt, and more.

Rate-and-Term Refi vs. Cash-Out Refi

Rate-and-Term Refi
Cash-Out Refi
Take advantage of low interest rates
Tap into your equity to get cash
Chance to get better loan terms
Replace current loan with a bigger mortgage
Opportunity to build equity faster
Cover home renovations, pay debt, etc.

Is Now a Good Time to Refinance Your Mortgage?

If you’ve been thinking about refinancing your mortgage, then you may want to act soon. Interest rates fell to historic lows in December 2020. But that doesn’t mean that rates will stay low forever. While interest rates continue to hover around all-time lows, they have been starting to inch up. So, now’s a great time to consider refinancing your mortgage while rates are still low.

Historically Low Rates Are Starting to Climb

Month & Year
Interest Rate
December 2018
4.55%
June 2019
3.73%
December 2019
3.74%
June 2020
3.13%
December 2020
2.67%
June 2021
3.02%

Source: Macrotrends

How Much Could You Save By Refinancing?

In case you’re wondering how much you could save by refinancing, let’s dig into an example to give you some idea. Let’s say our hypothetical homeowner got a mortgage in 2018 when the average rate for a 30-year mortgage was 4.54%. In this hypothetical, they buy a $250,000 home and put 10% down. Based on 2018 rates, the monthly payment (principal and interest) would be about $1,145.

Fast forward to today when rates are around 3%. A $250,000 home with a 10% down payment would result in an estimated monthly payment of just $948. That’s a difference of $197 a month and $2,364 a year. Over the course of the 30-year mortgage, that would add up to about $70,000 in potential savings. So, refinancing a mortgage from 2018 to 2021 rates can amount to significant savings over time.

Of course, several factors will influence your actual savings. For instance, exact savings will vary based on the original mortgage rate, current mortgage rates, the amount of home equity you’ve built, and your new terms. But in general: you could save thousands of dollars by refinancing.

What Are Common Refinance Requirements?

The process of refinancing your mortgage will be similar to the process you went through to obtain your original mortgage. During the refinancing process, you’ll need to meet several common requirements. Requirements vary from lender to lender, but we’ll cover the most common below.

Home equity

Your home’s equity plays a big part in your refinancing options. Generally speaking, many mortgage lenders require that a home has at least 20% in equity before it qualifies for refinancing.

Credit score

While a lower credit score doesn’t automatically take refinancing off the table, those with higher credit scores are more likely to get the lowest rates. Many lenders require a credit score of 620 or above. However, some federally-backed loans have lower credit score requirements.

Debt-to-income ratio

Ideally, mortgage lenders prefer that less than 35% of your income is consumed by debt. However, a higher DTI may be considered, especially if the refinance helps to lower the percentage. Those with more than a 50% DTI may find it more difficult to refinance.

Frequently Asked Questions

Can you refinance your home with bad credit?

Having a bad credit score doesn’t make it impossible to refinance a mortgage. Every lender has its own eligibility standards, so you can shop around to compare requirements. Also keep in mind that lenders consider other factors, including how much equity you’ve built.

Do you need to use your original lender to refinance your home?

No, you don’t need to use your original lender to refinance your mortgage. In fact, you may find that other lenders offer more favorable terms and rates. Before refinancing, take a moment to shop around and compare top lenders.

How are refinance loans and home equity loans different?

While refinance loans replace your old mortgage with a new mortgage, home equity loans are separate loans. So, a home equity loan is in addition to your mortgage and doesn’t change the terms of your mortgage.

Can you refinance VA loans and other government-backed loans?

Yes, federally backed loans like VA and USDA loans can be used for mortgage refinance. Often, federally backed loans come with lower interest rates, fewer income requirements, and looser credit score requirements.

How does the HIRO refinance program work?

Most mortgage refinance programs require at least 20% equity, but the High LTV Refinance Option (HIRO) program waives this requirement. Even homeowners who are underwater on their mortgage may qualify. This program is for conventional loans backed by Fannie Mae.

Too Long, Didn’t Read?

After reaching historic lows at the end of 2020, mortgage refinance rates are still near all-time lows. But rates fluctuate over time, and many experts believe rates will rise in 2021. So, if refinancing has been on your mind, then you may want to act now. Take the next step by comparing top mortgage refinance lenders and walk away with the best refinancing rates.