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Refinancing a mortgage loan can save you money, reduce your monthly payment or help you achieve other important financial goals. But there are some costs to consider before you decide to apply.
Mortgage refinance closing costs can range from 2% to 6% of the loan amount, so with a $250,000 loan, it could cost between $5,000 and $12,500 to finalize the loan. Depending on the situation, those upfront costs can be worth it (and some may be included in the loan or waived depending on the lender), but it's important to compare the benefits and costs to ensure that's the case.
What Is Mortgage Refinancing?
Refinancing a mortgage involves replacing your existing loan with a new one, either through your current lender or a different one.
There are a few different reasons why you might consider refinancing a mortgage:
- Lower interest rate: If market rates have dropped or your credit and financial situations have improved since you first applied, you may be able to score a lower interest rate, which could save you on your monthly payment and cut the total amount of interest you'll pay.
- Lower monthly payment: Even without a lower interest rate, you could refinance your mortgage to a loan with a longer repayment period, reducing your monthly payment. Just keep in mind that this typically results in more interest paid over time.
- Switch interest rate types: Adjustable-rate mortgages are appealing because they start off with a lower interest rate than a fixed-rate mortgage, and you'll typically maintain that rate for the first three, five, seven or even 10 years. Once that fixed period ends, though, your rate can fluctuate with the market. If you want to switch from an adjustable rate to a fixed rate, a mortgage refinance is the only way to do it.
- Tap your home equity: If you need some extra cash to pay down high-interest debt, finance a home improvement project or buy an ex-partner out of ownership, a cash-out refinance allows you to borrow more than what you currently owe. The amount you can borrow will depend on how much equity you have, and the additional debt will be paid to you in cash.
Costs to Consider Before Refinancing a Mortgage
While there are some clear benefits to refinancing a mortgage loan, it's important to consider the costs associated with the process. According to the Federal Home Loan Mortgage Corporation (Freddie Mac), closing costs include:
- Government recording costs
- Appraisal fees
- Credit report fees
- Lender origination fees
- Title services
- Tax service fees
- Survey fees
- Attorney fees
- Underwriting fees
It's important to note that these fees can vary from lender to lender. For example, some digital mortgage companies don't charge lender fees at all. And some fees, such as origination, underwriting and title fees, can be negotiated.
How to Decide Whether Closing Costs Are Worth It
Whatever the fees may be for your particular mortgage refinance, it's important to compare the costs with the benefits.
As one example, let's say you're refinancing a $300,000 mortgage with a 30-year term and a 4.25% interest rate. The new loan rate is 3.25%, and you're keeping the same repayment period that you have now.
In this instance, the refinance reduces your monthly principal-and-interest payment from $1,476 to $1,306, a monthly savings of $170. Now, if the closing costs on the refinance total $9,000, it will take you roughly 53 months, or almost four and a half years, to break even with the monthly savings.
If you're planning on staying in your home longer than that and don't anticipate refinancing again during that period, it's worth it. But if you think you'll sell the house before you reach that break-even point, the costs outweigh the savings.
Doing a cost-benefit analysis on other mortgage refinance purposes can be more challenging because there isn't necessarily a clear way to compare what you'll get with what it'll cost you. But it's still a good idea to consider both the benefits and drawbacks.
It's also important to note that you can often roll the closing costs into your new loan. While this saves you money upfront, it can cost you more in the long run because you're now paying interest on closing costs in addition to the principal loan amount.
How to Refinance a Mortgage
If you've decided you'd like to move forward with the process, here are some steps you can take to refinance your home mortgage:
- Check your credit to determine if you're in a better place than you were when you accepted the first mortgage.
- Understand your goal for refinancing, whether it's to get a lower interest rate or monthly payment, switch to a different type of interest rate or get some cash from your equity.
- Shop around and compare interest rates and closing costs.
- Choose a lender and lock in an interest rate, then provide all of the documentation and information the lender requires to close on time.
In most cases, you can refinance your mortgage loan soon after you closed your first one. However, there are some instances with a waiting period, so check with your lender before you apply to avoid unnecessary credit checks.
During this process, it's crucial that you avoid applying for any other type of credit. If you open a new loan or credit card account just before you apply for a mortgage refinance, it could impact your ability to refinance.
That said, refinancing a mortgage loan typically won't impact your credit score too much, especially if you're not doing a cash-out refinance because you're not changing how much you owe. The hard inquiry generated when the new lender pulls your credit and the closure of the old account could affect your credit scores slightly, but the decrease is typically only temporary, all other things being equal.
Make Sure Your Credit Is Mortgage-Ready
Long before you apply for a mortgage refinance, check your credit score and review your credit report to get an idea of where you stand. Even if you can get a lower interest rate with your current credit and financial situation, you could save even more if you can improve your credit before you apply.