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Mortgage Refinance 101: What It Is and When You Should Do It

April 11, 2020

What is a Mortgage Refinance?

A mortgage refinance is when you transfer the loan on your house to a new mortgage with new rates. The new mortgage pays off the balance on the previous one, allowing you to take advantage of better terms and interest rates without a disruption in lending.

Some of the reasons that people choose to do a mortgage refinance are:

  • To lower interest rates
  • To move from a variable interest loan rate to a fixed interest loan rate
  • To reduce monthly payments
  • To switch to a new mortgage provider
  • To cash out home equity
  • To get rid of private mortgage insurance (PMI)

A new survey by Bankrate, a consumer financial services company, found that 7 out of 10 mortgage holders are either paying more than the average mortgage rate or don’t know what their rate is at all. Among respondents, the average interest rate was 4.41% (0.71% above the national average of 3.7%). With a mortgage refinance, these homeowners would be able to take control of their interest rate and take advantage of today’s record lows.

How Much Does a Mortgage Refinance Cost?

You’ll have to pay closing costs on your refinanced mortgage just like you did on your previous mortgage, with a nationwide average of around $2,000—or about 3% to 6% of the total loan amount.

The cost of a mortgage refinance varies depending on a few key factors, including your credit score, the loan amount, and who you’re borrowing from. Here’s how the closing costs for a mortgage refinance break down, according to LendingTree:

Loan application/origination fee – 0% to 1.5% of the loan balance

Underwriting fee – 1% of the loan balance

Home appraisal fee – $300 to $500 for a single family home, $600+ for a multi-family home

Yield-spread premium – 0.25% to 1% of the loan balance

Title insurance fee – 0.5% of the loan balance

Credit report fee – $30 to $100

Pre-payment penalty fee – Varies by lender, but generally about one to six months’ worth of interest or a set percentage of the remaining balance on the principal of the loan. Pre-payment penalty fees come into effect when loans are paid off early, usually three to five years after they were first taken out. However, not all lenders charge this fee.

Discount points – You’ll have the option of paying for discount points, also referred to as mortgage points, with one point equaling 1% of your loan balance. Discount points lower your monthly payment and make you eligible for a lower interest rate.

Note that closing costs for a mortgage refinance will look a bit different if you are a veteran who purchased your home through a VA loan. You can learn about the refinancing process for VA loans here.

Talk to your lender to see if you qualify for a no-closing-cost mortgage refinance, which allows you to fold the closing costs associated with refinancing into your loan amount in return for a slightly higher interest rate. Some mortgage companies will also offer incentives to keep you as a customer instead of having you switch to another provider, such as removing the requirement for a new appraisal.

So, Should You Refinance?

Whether or not it’s a smart idea to undertake a mortgage refinance will depend on your current loan situation, your refinancing options, and how the associated closing costs compare to what you’re spending each month. To the latter point, it’s important that your closing costs don’t offset the savings that you get from lowering your interest rate. Use a refinancing calculator to get an estimate of what you might be able to expect.

A mortgage refinance isn’t a guarantee of a lower interest rate. Do plenty of research—and ask your lender plenty of questions—to ensure that the terms and rates on the new mortgage are going to be preferable to your current mortgage. You may want to consider working with a mortgage broker as well. While their services aren’t free, they’ll be able to walk you through what you need to know in order to decide whether a mortgage refinance is a good way to go, and can help ensure that you come out with the best terms and rates.