How to Refinance Your Mortgage to Save Money and Consolidate Debt

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Refinancing your mortgage, which is the process of paying off your existing home loan and replacing it with a new loan, can save homeowners money. But before you consider a mortgage refinance, you should understand how much it costs and what the process entails.

In this guide, we’ll explore how to refinance a mortgage, how much it costs to refinance and how to decide whether you should refinance at all. We’ll also discuss the refinancing process and offer comparison-shopping tips.

How to refinance your mortgage

Before we cover the steps you need to take to refinance a mortgage, we first need to understand the different refinance options available. Below is a table of the types of refinances and the process involved for each in refinancing your mortgage.

Types of mortgage refinances

Refinance Type

How Does It Work?

Cash-out A way to borrow against your available equity. You take out a new mortgage with a larger balance than your existing loan and pocket the difference in cash.
Limited cash-out The refi closing costs and fees are financed into the new loan, and you may receive a small amount of cash — not to exceed 2% of the loan amount or $2,000, whichever is lower — when the closing documents are reconciled.
No cash-out Also called “rate-and-term” refinance. You refinance your existing loan balance to improve your loan terms by securing a lower mortgage rate or switching mortgage types, for example. You can either pay your closing costs and fees out of pocket or finance them into your new loan.
Streamline A refinance with limited documentation and underwriting requirements. The goal is to lower your monthly mortgage payment. Streamline refinances are available on government-backed mortgages through the FHA, USDA and VA.

Step-by-step guide to shopping for a mortgage refinance

Before you start shopping for a new mortgage, arm yourself with knowledge. First, check mortgage refinance rates in your area online.

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It’s good to know what the best rates are, but it’s even better to know if you’ll qualify for them. About six months before you plan on applying for a refinance, pull a copy of your credit report from each of the three major credit reporting bureaus — Equifax, Experian and TransUnion. Review your reports for accuracy and dispute any errors you find. You’ll also want to access your credit scores to see where you stand.

Aim for a score of 740 or higher to qualify for the lowest mortgage rates. You can still qualify with a lower credit score, but the lower your score, the higher your interest rate will be. We offer separate tips on how to refinance a mortgage with bad credit.

Choose your rate type
Decide which rate type works for you. For example, do you have an adjustable-rate mortgage and want to switch to a fixed-rate mortgage? Mortgage rates might be lower now, but eventually they’ll increase. If you have a 5/1 ARM, your mortgage rate is fixed for the first five years, but will adjust annually thereafter. Unless you know with certainty you can afford your monthly payments when your rate starts rising, or you aren’t planning to stay in the home for long, an ARM is risky.

If you don’t want to gamble with your monthly mortgage payment, stick with a fixed-rate mortgage. Your rate will be locked in for the life of your loan.

Gather multiple quotes

As with most shopping endeavors, the best way to find the best price is to get quotes from multiple mortgage lenders in your area.

There are two primary criteria for you to consider. The first, of course, is interest rates. The second is fees, which can eat into your savings.

It’s easy to take the path of least resistance and refinance with your current lender, which may offer you lower fees than their competitors. But the interest rates offered by your current lender may be higher than what’s available with other lenders. Get outside quotes to use as leverage for negotiations.

Or maybe your lender is offering you lower fees and interest rates than the competition, but the rate is still higher than you’d like it to be because of a less-than-perfect credit score. While doing so doesn’t have a high success rate, you can try negotiating for a lower rate based on customer loyalty.

Prepare your documents

Gather these commonly required documents before approaching your lender to ensure the application process goes as smoothly as possible:

  • Personal information: Be prepared with your Social Security number, driver’s license or other state-issued ID, and the addresses you have lived at for at least the past three years. Lenders are required to verify your identity before lending you any money or allowing you to open any type of financial account.
  • Accounting of debts: Statements for any outstanding credit card balances or loans you may have, including your current mortgage.
  • Proof of employment and income: Last two to three months’ worth of pay stubs, employer contact information, including anyone you’ve worked for in the past two years, W-2s and income tax documents for the past two years and/or additional documentation of income for the past two years for self-employed individuals, including schedules and profit/loss statements.
  • Proof of assets: A list of all the properties you own, life insurance statements, retirement account statements and bank account statements going back at least three months.
  • Proof of insurance: This generally refers to homeowners insurance and title insurance.
  • Additional documents: If you receive income from disability, Social Security, child support, alimony, rental property, regular overtime pay, consistent bonuses or a pension, be sure to provide documentation for these income sources as well.

There may be additional documents required depending on your lender, but checking off this list is a great start.

Apply for the refinance

Once you’ve done your homework and gathered all your information, apply for the refinance with the lender you’ve selected.

How long does it take to refinance a mortgage?

The full process of being approved for a mortgage refinance typically takes between 20 and 45 days if you submit your paperwork in a timely manner. It will require hard pulls of your credit reports and scores, along with the submission of personal documentation.

Approval
A loan officer will look over your paperwork, which will hopefully end in approval. You’ll then be sent documents to review. It would be wise to do so with a lawyer, which is an additional fee you’ll want to consider as part of your refinancing costs.

Closing
If everything checks out and you agree to your new loan terms, then it’s time to finalize the deal with your mortgage closing. If you didn’t finance your closing costs and fees as part of your new loan, you’ll pay for them at closing time. Depending on the lender, you’ll sign your documents in person, through postal mail or online. After the paperwork is processed, your current mortgage will be paid off and your refinanced mortgage will take effect.

Should you refinance your mortgage?

There are many reasons you might consider refinancing your mortgage. For example, interest rates could have dropped significantly since you first bought your house. You may also have a growing list of home repairs that need to be addressed, or high-interest credit card or student loan debt to consolidate, and a refinance can help you achieve those goals.

But are any of these good reasons to refi? To decide, you need to factor in the cost of refinancing a mortgage, along with some other considerations. We’ll weigh the pros and cons of refinancing for various goals below.

Refinancing to lock in a lower mortgage rate

Mortgage interest rates have been historically low for a while. As of mid-September 2019, the average interest rate on a 30-year fixed-rate mortgage was 3.56%, according to Freddie Mac’s Primary Mortgage Market Survey. During the same week in 2018, the average rate was 4.6%. If your original mortgage rate is higher than 4%, it might make sense to explore your refinance options, since a lower interest rate can save you money over time.
See the table below for an illustration of how a lower interest rate can reduce the overall cost of your mortgage.

 Existing mortgage New mortgage

Loan amount

$290,921.36 $290,921.36

Years remaining on term

28 years 30 years

Interest rate

5%4%

Monthly payment
(principal and interest)


$1,610.46 $1,388.90

Total interest paid
(over 30 years)


$279,767.35 $209,083.75

Let’s say you’re refinancing a 30-year mortgage you undertook two years ago, and you now qualify for a mortgage rate that’s a full percentage point lower than your current rate — you’re going from 5% to 4%. Although a refinance will mean it will take longer to pay off your loan, the trade-off is the money you’ll save. Based on the table above, your new mortgage rate would lower your monthly payment by $221.56 and cut down your interest payments by more than $70,000 over the life of the loan.

How much does it cost to refinance a mortgage?

The savings sound promising, but hold your enthusiasm. Don’t forget to answer this key question before moving forward: How much are the closing costs to refinance a mortgage?

A refinance comes with closing costs and fees that could range from 3-6% of the new loan amount. Charges usually include escrow and title fees, document preparation fees, title search and insurance, loan origination fees, flood certification and recording fees. On a nearly $291,000 mortgage, these expenses could add up to more than $8,000 or more.

In order to truly save money through refinancing, you’ll need to determine your break-even point, which is the amount of time it will take for your monthly payment savings to cover the costs you paid for the refinance. Using the numbers above, we would need to divide the estimated closing costs — let’s just use $8,000 in this example — by the $221.56 monthly payment savings. The math tells us it would take about 36 months — or three years — to break even. If you don’t plan on staying in your home for at least three years or longer, you should probably keep your existing mortgage.

Refinancing to lower your mortgage payments

If you’re thinking about refinancing to lower your monthly mortgage payments, you should understand that while you’ll pay slightly less every month, the amount you pay over the life of your loan will increase.

Refinancing simply to lower your monthly payment can be dangerous during the first five to seven years of paying off your current mortgage. That’s because interest charges are not spread out evenly over the course of your loan — they are front-loaded. That means for those first several years, you’re paying more toward interest than your principal loan balance. In the meantime, you’re building very little equity. If you refinance during this time frame, you’re starting the clock over and delaying the opportunity to establish equity.

Revisiting our previous example, let’s say instead of refinancing your 30-year, $300,000 mortgage after a couple of years, you waited until you were 10 years into the loan to refinance. Your goal is to lower your monthly mortgage payment, but in order to get the payment as low as you want, you extend your loan term by 10 years and start over with a new 30-year mortgage.

On your existing mortgage, nearly $600 of your monthly payment goes toward paying down your principal by year 10. If you were to start over, the amount you’d pay toward principal drops down to less than $400 for the first few years.

Refinancing to make home improvements

Some homeowners choose to pay for home improvements by refinancing a mortgage, especially if they don’t already have the cash on hand.

Cash-out refinance

One way to do that is through a cash-out refinance, which is when you borrow a new mortgage with larger balance than your existing mortgage. The difference between the two loans is given to you in cash. That available cash comes from the equity you’ve built from paying down your existing mortgage.

A cash-out refinance could work for you if you have built a significant amount of equity in your home. Most lenders limit the maximum loan-to-value ratio — the percentage of your home’s value that is financed through your mortgage — for cash-out refinances to 80%.

Choosing a cash-out refinance could make more financial sense than borrowing a personal loan or putting repairs on a credit card, since refinance interest rates are typically lower than those alternatives.

HELOC

Another option is to borrow a home equity line of credit (HELOC). This functions similarly to a credit card; you have a line of credit up to a set amount and only pay for what you borrow, plus interest. However, because a HELOC is secured by your home, interest rates are typically much lower than on credit cards. However, rates are generally variable and not fixed, which could cause problems later if you’re carrying a large balance on your HELOC and interest rates go up.

HELOCs usually have a draw period, when you’re allowed to borrow against the credit line, and a repayment period, when you can no longer borrow and are only repaying what you owe. During the draw period, the required minimum payments usually just cover the interest, but during the repayment period, you’ll have to make principal and interest payments that will likely be much higher than your interest-only payments — especially if your outstanding balance is high.

Either way, you should be cautious. Making an upgrade for the sake of functionality is one thing, but making an upgrade for the sake of luxury is another. If you’re thinking about tapping your equity to pay for a major project that may not boost your home’s value, it might not be wise to do so. If the luxury is something you really want, don’t finance it — save up for it.

Refinancing to consolidate debt

You might be tempted to use a cash-out refinance to pay off credit card balances or other high-interest debt. With mortgage interest rates hovering near historic lows, taking this route may seem like a good idea. After all, rolling your debt into a mortgage with a 4% interest rate is better than paying it off at 15% interest or higher, isn’t it?

Credit cards

There are some instances where rolling your credit card debt into a mortgage refinance can be advantageous. For example, if you’re in a dual-income household and you lose a spouse without adequate life insurance, you may find yourself in a financial bind.

In this scenario, if you have credit card debt in your own name and suddenly can’t afford to pay the monthly bills, refinancing your mortgage and cashing out a portion to pay off your debt may be one of the few feasible options.

Let’s say you owe $20,000 in credit card debt at a 15% interest rate. If you pay off that balance over the next five years, you’ll pay more than $8,500 in interest. However, if you add that same balance to a mortgage with a 4% interest rate, although you’re increasing your loan amount, you’ll likely pay less interest than if you kept the debt on your card.

Outside of scenarios similar to the one mentioned above, refinancing your mortgage to consolidate credit card debt often doesn’t get to the root cause of the issue. If you had a spending or cash flow problem prior to your mortgage refinance, you’re likely to end up in debt again. But this time, you’ll have a bigger mortgage to handle on top of the extra debt.

Instead of borrowing a bigger mortgage to get rid of your credit card debt, consider applying for a balance transfer credit card. Though these cards come with balance transfer fees, they can be as low as 3%, and you only have to pay them once. Many cards include an initial 0% interest offer on balance transfers for the first 15 months or longer. Because there is a deadline on the 0% interest period, you’ll likely find the motivation to pay the debt off quickly and build better financial habits along the way.

Student loans 

If you have student loan debt that could take decades to repay, refinancing your mortgage to access the cash you need to pay off that debt could potentially be a smart idea.

Fannie Mae, one of the two mortgage agencies that buy and sell mortgages from lenders that conform to their guidelines (the other agency is Freddie Mac), has a “student loan cash-out refinance” option that allows borrowers to refinance their mortgage and cash out a portion of the new mortgage to pay off student loans.

Let’s say you owed $30,000 on your home and had $20,000 in outstanding student loan debt. You would take out a new $50,000 mortgage, with $20,000 of it paying off your debt.

Going this route could make sense if the interest rate on the refinance is less than the interest rate on your student loans. Additionally, if you sell your home, the proceeds should take care of the portion of your mortgage that was dedicated to paying off your loans.

The drawback of refinancing to consolidate or pay off debt is that not only do you increase your mortgage balance — you lose your available equity. Be sure to weigh the pros and cons before tapping your equity.

The bottom line

A mortgage refinance can save you money, cut down on your interest payments or give you access to cash, but be sure you’re clear on why you’re refinancing and whether it makes sense.

If you’re refinancing to extend your loan term by several years and dramatically lower your mortgage payments, or remodel your kitchen to something of a chef’s dream, reconsider. But if you’re looking to snag a lower mortgage rate on a loan for which you’ve built significant equity, refinancing may be beneficial.

Before signing on any dotted lines, reach out to your loan officer, ask questions and run the numbers.

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Crissinda Ponder
Crissinda Ponder |

Crissinda Ponder is a writer at MagnifyMoney. You can email Crissinda here

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