Mortgage refinancing is what happens when you pay off an existing mortgage loan using funds from a new mortgage loan. Then, the new mortgage takes the place of the old one, and you pay it off over time.
Some homeowners decide to refinance in order to take advantage of lower interest rates or to pay off their loan sooner. (For example, as of July 2021, the average rate on a 30-year fixed-rate mortgage was about 3.2%.) Others refinance to access their home equity to pay for home improvements or other expenses. If you’re thinking about refinancing your mortgage due to the historically low interest rates in 2021, consider these key facts about the process before you jump in.
- Refinancing your mortgage will likely result in changes to the length and interest rate from the original loan.
- You may be able to take cash out on your home's equity when you refinance.
- When refinancing, you should consider your current financial situation and whether you'll be in the home long enough to reach a "break-even point."
How Long It Takes to Refinance
The refinancing process is just like the process you went through with your initial mortgage. You’ll fill out an application, submit your documentation, await underwriting and processing, and finally close on your loan. The exact time the process takes depends on the lender you choose and the overall market demand. For example, a lender that is dealing with more applications or a sudden surge in demand may take longer to process a loan than one with less business.
In June 2020, the average time to close on a refinanced mortgage was 48 days, up from 44 days in May 2020.
The average time to close on a refinanced mortgage was 35 days in March 2020 (the lowest of the year thus far), before increasing to 39 days in April 2020.
How the Length of Your Loan Changes
Since refinancing replaces your old loan with a new one, it changes the length of your loan term as well. Depending on which new loan product you choose, that term could be longer or shorter than your old one.
Here are a few examples that may help:
- Suppose you have 20 years left on your home loan, but you refinance into a new 30-year mortgage. In that case, your term would get longer. You’d have another 30 years until the loan is paid off.
- Take that same 20-year scenario. This time, you refinance into a 15-year loan, which actually shortens the time it takes to pay it off.
The difference will depend on your goals for refinancing. If you want to pay off your loan sooner or want to pay less in lifetime interest, refinancing into a shorter-term loan can help (though it may mean a larger monthly payment as a result). If you’re simply looking for a lower payment, choosing a longer-term loan is usually best.
It's important to consider the interest rates for both 30-year and 15-year mortgages. Both decreased to historic lows in October 2020.
Costs of Refinancing
Your refinancing costs will be very similar to what you paid when initially applying for your mortgage. You’ll need to pay for things like a credit check, title search and policy, appraisal fees, origination and underwriting fees, and more. According to Freddie Mac, the average cost to refinance is almost $5,000.
Once you apply for preapproval with a lender, they’ll give you a loan estimate detailing the expected costs for your specific refinance.
You Can Get Cash From a Refinance
If you’re in need of cash—to pay for home renovations, medical bills, college tuition, or even to pay off high-interest debts—a refinance can be a good option. Dubbed “cash-out refinances,” these allow you to take out a loan larger than the one you have now, keeping the difference in cash.
The amount of cash you can take out will depend on your home’s value and how much equity you have in the property.
Here’s an example: Suppose you made a $50,000 down payment on your home and have paid $20,000 toward your principal since buying it. You have $70,000 in total home equity. As long as your home hasn’t lost value, you could tap a large portion of that via a cash-out refinance. (You’d have to meet the lender’s other qualifying requirements, too.)
The traditional type of refinance is called a "rate-term refinance." You can’t get cash from those loans, but you can adjust your term (length of the loan), its interest rate, or both.
When Refinancing Is or Isn’t Worth It
To understand whether mortgage refinancing is worth it, you need to have a good grasp on your finances and your long-term goals.
First, how long will you be in the home? You want to be in the home long enough to reach what’s called the “break-even point"—the point in time when the money you saved on the refinance outweigh the costs of refinancing. If you plan to move in the next five years, and it will take 10 years to realize the savings of your refinance, then it’s likely not the best move for your finances.
You also need to take into account your personal financial situation. If money is tight, or your earnings have been cut, refinancing into a lower rate and longer loan term may be necessary to make your monthly payment more affordable.
The Bottom Line
Regardless of what type of refinance you’re considering, it’s important to shop around when refinancing. Get estimates from several lenders, and compare the costs, mortgage rates, and other terms of each one you receive. These tend to vary significantly across lenders.