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Mortgage Basics

6 Steps to Refinancing Your Home Mortgage

Refinancing your mortgage can help you reduce your loan's interest rate or your monthly payment, gain access to some of your home's equity, or change your loan program.

The process of refinancing a mortgage is similar to the one you went through to get your mortgage loan in the first place. The Federal Reserve cut its target interest rate to 0% in March 2020, which could cause mortgage interest rates to drop in turn. The average rate at the beginning of April was 3.74%, and people with excellent credit could qualify for a rate that's even lower.

Here are six steps to refinancing your mortgage to take advantage of the potential benefits the process offers.

1. Check Your Credit

Having good credit has a lot of perks, and if your credit score has improved since you got your first mortgage loan, it could improve your chances of getting a lower interest rate than you're currently paying. So before you start the application process, check your FICO® Score to understand your current situation. Once you know your FICO® Score, take a look at the score range to see where you stand:

  • Exceptional: 800 to 850
  • Very good: 740 to 799
  • Good: 670 to 739
  • Fair: 580 to 669
  • Very poor: 300 to 579

You can check your credit reports and scores through Experian for free. Many conventional mortgage lenders may approve your loan application if your FICO® Score is 620 or higher, but scores in the mid-700s and above will give you the best chance of scoring a low rate.

In addition to your credit score, lenders will also look at other factors, such as your payment history, recent credit applications, your credit utilization ratio, major negative items like bankruptcies and foreclosures, and more.

As a result, it's also important to check your credit report to make sure there aren't any inaccuracies listed. If you find something that you believe is incorrect or fraudulent, dispute it with the credit reporting agencies. If it's determined that you're correct, the item will be corrected or removed, which may make it easier to get a better loan rate.

2. Determine Your Target Rate

Mortgage interest rates change daily, and sometimes multiple times a day. With so many updates, it's important to do your research on current rates and trends.

But just because interest rates are lower than what you have now, it doesn't necessarily mean you'll save money. That's because, just like the initial mortgage process, refinancing comes with closing costs that can range from 2% to 6% of the loan amount.

As a result, you'll need to determine a target interest rate that would net you interest savings equal to or greater than your closing costs. Using an online mortgage calculator, determine how much money you'd save in interest with the lower rate each year, then divide the closing cost amount by that figure to find out how long it'd take you to break even.

If you're planning on staying in the home for longer than that period, you'll ultimately save money.

Also, it's important to consider that your goal of refinancing may not be to get a lower interest rate. For example, you may have an adjustable-rate mortgage and want to switch to a fixed interest rate to avoid rate fluctuations in the future, or you might want to get a cash-out refinance to tap some of the equity in your home. Work with a professional to help you run the numbers to make sure doing this is the right financial option for you.

3. Shop Around and Choose a Qualified Lender

Shopping around is one of the best ways to score a lower interest rate on your new mortgage loan. Each lender has its own set of criteria for determining interest rates, and you may be able to qualify for a lower rate with one than with another.

Also, closing costs and fees can vary from lender to lender, so comparing multiple options can help you maximize your savings. Plan to get at least three or four quotes from mortgage lenders to give you a good idea of what you can qualify for. This process may also help you gain some power in negotiations as you seek to reduce your costs from interest and fees.

Also, fortunately, submitting applications with multiple lenders won't have a significant negative impact on your credit score. That's because credit scoring models typically combine multiple inquiries from mortgage, auto and student loan applications, as long as you submit all of your applications within a short period—typically between 14 and 45 days depending on the model.

4. Watch Out for High Lending Fees

Every lender has its own set of mortgage refinance loan fees, which means some lenders may charge fees others don't. Also, some lenders may charge more for certain services than others.

Common fees associated with refinancing a mortgage include:

  • Escrow and title fees
  • Lending fees
  • Appraisal fees
  • Credit fees
  • Insurance fees
  • Property taxes
  • Origination fees
  • Interest rate discount fees (also called points)

The lower the fees, the less time it will take to break even with the savings you're gaining from a lower interest rate. Lenders will typically provide a loan disclosure with an estimate of closing costs, so make sure to itemize the different fees and compare them with costs from other lenders.

5. Be Patient About Signing a Mortgage

A mortgage loan is a significant financial commitment, so it's crucial that you take the time to read the full terms of your new contract. In addition to understanding the fees associated with the loan, also determine whether you'll be charged a prepayment penalty if you pay off the loan too early—which can happen if you refinance again or sell the home.

Also, read through all of the contract clauses to make sure you understand the entire scope of the contract with the new lender. If you don't understand a term, don't hesitate to ask for clarity.

In some cases, the lender may try to pressure you to sign quickly. If you ever feel uncomfortable about the process, consider working with a different lender. Also, note that mortgage lenders will typically allow you to lock in an interest rate—typically for 30 to 60 days, but sometimes for as long as 120 days—which should give you plenty of time to make sure you're ready to go through with the process.

And if interest rates drop even lower during the rate lock period, you can talk to your lender "floating down" your rate to the current rate for a fee or simply start the process over with another lender.

6. Don't Open Any Credit During the Refinancing Process

In the time leading up to your mortgage refinancing, it's imperative you don't apply for new credit cards or loans. Because the mortgage lender will check your credit at the time of application and before closing, it's also critical to avoid opening credit accounts during the refinancing process.

There are a few reasons for this advice:

  • Credit score: Every time you apply for credit, the resulting hard inquiry can knock a few points off your credit score. Depending on where your credit score stands, losing even a handful of points could impact your interest rate on the new loan. Avoid any action that could negatively impact your credit score.
  • Debt-to-income ratio: Your debt-to-income ratio—the percentage of your gross monthly income that goes toward debt payments—helps determine how much you can borrow in terms of your monthly payment. Adding more debt will increase your ratio, and depending on where it was at before the new loan, it could make it challenging to get approved for the loan amount you want.
  • Risk: A mortgage loan isn't just a big commitment for you; it's also a big commitment for the lender. If you're opening one or more credit accounts shortly before or during the refinancing process, it could cause a lender to think you're struggling financially and relying on debt to meet your financial obligations. In that case, a mortgage lender may lose confidence in your ability to make your monthly mortgage payments on time and either deny your application or charge a higher rate.

As such, if you're hoping to get a new credit card or car loan, wait until after you've closed on your refinance loan to apply for those credit accounts.

Make the Best Decision Based on the Numbers

Refinancing a mortgage may seem like a simple process, but it involves a lot of moving parts, including costs and the potential for savings.

Avoid rushing the process in an effort to get it behind you. Take your time to shop around and research your options, and take advantage of the fact that mortgage lenders will lock your rate for a set period to review the costs and savings, run the numbers, review the terms and conditions of the contract and decide whether it's the right fit for you.

Also, keep in mind that if your credit has improved, but you've still got some room to run, you will have the opportunity to refinance again in the future.