Refinancing your mortgage can be a great way to save money or access some of the equity in your home. But the process can be time-consuming and complex. This guide outlines the six easy steps you’ll need to follow to refinance your mortgage, from checking your credit score to gathering documents to closing the loan.
Here’s how to refinance your mortgage in just six steps:
Step 1: Set a goal
Your approach to refinancing your mortgage will depend on whether you’re most interested in getting a better rate, lowering your monthly payment, or tapping into your home’s equity. So, decide what your goal is first:
- I want a lower interest rate. The interest rate you can qualify for when refinancing a mortgage will depend on market interest rates, your credit score, and how long you want to take to repay your loan.
- I want a lower monthly payment. If you need some more room in your monthly budget, you might want to refinance to get a lower payment. One way to do this is to extend your repayment term. But keep in mind, this could cause you to pay more in interest over the life of your loan.
- I need to pay for home improvements or other big expenses. If you plan on making some home improvements, tapping into your home equity can be a smart way to finance it.
Step 2: Review your credit, DTI, and income
Before moving on, make sure your financial health is in order. There are three major factors involved in getting approved for a mortgage:
- Credit score: Get copies of your credit history from all three credit agencies through AnnualCreditReport.com and make sure there are no outstanding issues or mistakes. Anything you can do to improve your credit score can help you get a better rate.
- DTI: Depending on your loan type, your maximum debt-to-income ratio for mortgage should be anywhere between 31% and 45%. The formula to calculate your DTI is: (Total monthly debt) / (Gross monthly income) x 100 = DTI. For example, if your total monthly debt payments are $2,300 and you earn $6,000, then your DTI is 38%.
- Income: Ensure your income is steady and stable before taking the next step to refinancing.
Step 3: Find out how much equity you have in your home
If you want to make some home improvements, using your home equity can be a good idea. Or if you need to pay for other larger expenses, you can use your home equity to get cash through a cash-out mortgage refinance.
To calculate how much equity you have, research your home’s value, then subtract your mortgage balance from the amount. For example, if your home is worth $300,000 and your mortgage balance is $200,000, your home’s equity is $100,000.
Tip: You’re generally limited to borrowing 80% of the equity in your home, though other lenders might have stricter limits. So if your equity was $100,000, for example, the maximum you could borrow would be $80,000.
Step 4: Compare lenders’ rates and fees
Because mortgage loans are so big, even small differences in interest rates can add up to thousands of dollars in savings. So it’s a good idea to compare lenders for the lowest rate.
Here is an example of how much you can save by refinancing a $300,000 balance with another 30-year repayment term but at a lower rate.
| Rate | Monthly Payment | Payments Over 10 Years | |
|---|---|---|---|
| Original loan | 3.75% | $1,389 | $166,680 |
| Refinance loan | 3.129% | $1,286 | $154,320 |
| Difference | 0.621% | $103 | $12,360 |
Most experts agree that you should only refinance a loan when interest rates are 0.5% to 1% lower than your current interest rate. Consider applying for a 15-year refinance loan if you want an even lower interest rate and can afford the higher monthly payment. This shorter term also reduces your lifetime interest costs.
Refinance rates don’t tell the whole story either. Make sure you understand what fees you’ll pay with each of your options.
Step 5: Get a loan estimate
Once you’ve compared real rates and fees from multiple lenders, you can get a loan estimate from the lender you’re seriously considering. The loan estimate is a standardized form that makes it easier to compare your options.
You’ll have to apply for a mortgage to get a loan estimate, which involves a hard credit check. But keep in mind, rate shopping allows you to apply for the same type of loan multiple times within a certain timeframe will only hit your credit score as a hard inquiry once.
Step 6: Prepare your documents and apply
After you’ve compared multiple lenders and loan estimates, choose the option that’s the best fit for your goals. The lender you choose will want some basic documentation from you, as well — to verify your income and assets.
You can generally expect to provide things like:
- Tax returns
- W-2s
- Paystubs
- Bank, savings, and retirement account statements
- Details on any assets or investments
- A copy of your driver’s license
Refinancing your mortgage can be a great way to save money on interest or access some of the equity in your home. With the right preparation and knowledge, you can make the process of refinancing your mortgage smooth and stress-free. By following these six easy steps and working with a qualified lender, you can refinance your mortgage and start saving money.
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