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Is Now a Good Time to Refinance Your Mortgage?

With mortgage rates at historic lows, now might be a great time to refinance your mortgage. It could help you lower your monthly mortgage payment and free up cash, which might put you in a stronger financial position to weather the current economic uncertainty. It's also an opportunity to switch to a loan with a shorter term or get cash for an emergency.

In addition to the low rates, however, there are some factors to consider when deciding whether refinancing is the right choice for you. But first, let's take a look at the different kinds of options that may be available to you.

What Is a Mortgage Refinance?

A mortgage refinance replaces your existing loan with a new one. The lender may require you to meet specific criteria, get preapproved, go through underwriting and sign closing documents.

There are several options to choose from:

  • Rate and term refinance: This type of refinance can be used to reduce your loan's interest rate, adjust the length of your repayment term—or both. Depending on what you do, this could either raise or lower your monthly payment.
  • Cash-out refinance: If you're looking to access some of the equity you've built up your home, this type of refinance can help you do that. It'll pay off your existing loan with a larger one and you'll collect the difference (minus fees). You may also qualify for a reduced interest rate.
  • FHA streamline refinance: You can obtain a lower rate on your FHA (Federal Housing Administration) loan, minus the credit check and appraisal processes that accompany other refinance options.
  • USDA streamline refinance: You can refinance a loan you received through the U.S. Department of Agriculture (a USDA loan), even if you have minimal or no equity.
  • VA interest rate reduction refinance loan (IRRRL): These loans lower the interest rate on loans available through the Department of Veterans Affairs. You can roll closing costs and processing fees into the new loan to avoid incurring out-of-pocket expenses when you refinance.

Why Now Might Be the Time to Refinance

Refinancing could have a host of benefits, especially for homeowners who have significantly improved their credit since they were originally approved for their mortgage. Here's why now may be the right time to move forward.

1. Lower Your Interest Rate

If you have good or excellent credit, refinancing now can help you take advantage of low rates and reduce your monthly payment. Lowering your interest rate by even a fraction of a percentage point could save you thousands of dollars over the life of your loan. A more affordable mortgage payment can also make you feel more financially secure in an unsteady economic climate.

2. Convert an Adjustable-Rate Mortgage to a Fixed Rate

If your mortgage payment keeps climbing due to changing interest rates and you're worried you soon won't be able to afford it, converting your adjustable-rate mortgage (ARM) to a fixed-rate loan might be wise. This will lock your interest rate and keep your mortgage payment constant for the duration of the loan term or until you pay off your mortgage. It's possible your new fixed rate will be slightly higher than your ARM rate, but you'll be saved from the possibility that your interest rate could spike in the future.

3. Use a Cash-out Refinance to Access Home Equity

You're able to use a cash-out refinance to tap into the equity you've built up in your home. You can use the money to fund a home improvement project, complete emergency repairs, pay off high-interest debts or take care of other expenses. You could also lock in a lower interest rate or a shorter repayment term in the process. Before you apply for a cash-out refinance, make sure you understand your loan limits and how it might change your monthly payment amount.

4. Eliminate Mortgage Insurance

Stuck paying private mortgage insurance (PMI) on an FHA loan? If you have equity of 20% or more in your home, you could save hundreds of dollars each month by converting your existing mortgage to a conventional loan product without PMI. You can use the extra cash to build an emergency fund that can help protect you if your financial situation changes.

What to Consider Before Refinancing

While there many benefits to refinancing, there are certain drawbacks to consider when making your decision.

1. Hefty Fees

Expect to incur closing costs when you refinance your mortgage. These can include the lender origination, appraisal, title and underwriting fees. Refinance closing costs, on average, run about $5,000, according to Freddie Mac. The closing costs you'll end up paying will vary based on a few factors, including the amount of your new loan.

Depending on how long you plan to live in the home, refinancing may not be a smart money move. You could even lose money if you relocate before you break even on closing costs. Let's say you pay $6,000 in fees to refinance your mortgage and lower your monthly payment by $150. At that rate, it would take a little over three years to recoup the funds spent to refinance your home loan.

If you're not working at the moment, it's possible your refinancing application will be put on hold until you have a steady income once again. If that delay happens, you may wind up wasting the money you spent on applying for the refinance and having your home appraised.

2. Changing Your Loan Term Could Have Consequences

If you choose a shorter loan term to save on interest, you may find yourself with a big monthly payment that stretches your budget too thin. By contrast, extending your loan's term can mean you'll pay more interest over the life of your loan, despite the lower monthly payment.

Here's how this might work in practice. Assume you have a 30-year conventional loan with a 5% interest rate. The initial loan was for $250,000, but you've paid it down to $225,678.97 over the past five years. So, you decide to refinance your mortgage to a new 30-year conventional loan with a 4% interest rate. This would take your monthly payment from $1,342.05 to $1,193.54, but you'll end up paying an additional $29,145.10 in interest by the time you pay off the loan.

How to Start the Refinancing Process

If you've run the numbers and decided the benefits outweigh the drawbacks, here's how to get started on your mortgage refinance.

Identify Your Goal

Refinancing a mortgage requires time, effort and money on your part. It's worthwhile to start by setting a goal to know what you're working towards. Is it a lower payment you're after or do you want to extend your loan term? Do you want to tap into your home equity to get the cash you need?

Taking this integral step helps you conduct a cost-benefit analysis to determine if refinancing your mortgage is the best move for your finances.

Check Your Credit

Lenders assess your creditworthiness to determine if you qualify for mortgage refinancing, and at what rate. Make sure your credit is in good shape before you apply.

Get a free copy of your credit report and review it to get an understanding of how your accounts and debt payment habits are recorded in your credit history. You can get free credit monitoring and view your FICO® Score for free through Experian as well.

If your score isn't quite where you want it to be, work on improving your credit to strengthen your approval odds and qualify for better rates. You can also explore mortgage refinance options for consumers with less-than-perfect credit.

Shop for a Lender

Explore mortgage refinance options available through traditional banks, online lenders, brokers and credit unions to find the lowest interest rate. Many lenders offer preapproval tools that allow you to view rates with no impact to your credit score. Be mindful that a hard inquiry could be generated if you decide to submit a formal loan application. The good news is hard inquiries only impact your score temporarily. They stay on your credit report for two years, but only impact your score for about 12 months.

For more information on the refinance process, see Experian's guide on how to refinance a home mortgage.

The Bottom Line

Ultimately, deciding if you should refinance your mortgage is a personal choice. Make sure you understand how the process works before moving forward. Additionally, you should perform an assessment of your current loan, as well as your credit and financial situations. All three should factor into your decision-making process. If needed, take some time before you apply to improve your credit to hopefully lock in an even lower interest rate.

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