Refinancing a mortgage means getting a new loan to replace your mortgage, which could lower your monthly payment or your interest rate. But lenders will charge you fees to refinance, just as they would for a mortgage. Here's what you need to know if you're considering whether a refinance loan is worth the cost.
What Does Refinancing a Mortgage Cost?
On average, homeowners can expect to pay 2% to 3% of the loan amount to refinance a mortgage. Refinancing a $300,000 home loan, for example, may cost $6,000 to $9,000.
These costs would be due at or before closing. Inspection and appraisal fees, for instance, you'd pay during underwriting for a refinance loan.
Generally, any type of refinance loan, including conventional mortgages, U.S. Department of Agriculture loans, U.S. Department of Veterans Affairs loans, adjustable-rate mortgages and Federal Housing Administration loans, require closing costs. The amount you pay can depend on the amount you're refinancing, the type of loan you currently have, the type of loan you're refinancing into, what your lender charges for closing fees and where you live.
"Not all of these fees are created equal, so you should request a breakdown when shopping around," says Brian Walsh, certified financial planner and manager of financial planning at lender SoFi. "Lenders might be willing to waive the application fee or lower the origination fee. Even if a specific lender is not willing to lower their fees, having a detailed breakdown from each lender will help you make an educated and informed decision."
These costs don't include what you might pay for private mortgage insurance when refinancing. Private mortgage insurance typically applies to conventional home loans when you put down less than 20%, but it can be removed when you reach 20% equity.
When to Refinance a Mortgage
The most important step in the refinancing process isn't necessarily getting a loan; it's determining whether refinancing makes sense for your situation. That involves looking at your short- and long-term financial goals, current mortgage terms, overall market conditions and reasons for refinancing, says John Dustman, senior vice president of consumer direct lending at Axos Bank.
You may be considering a refinance to save money on homeownership costs or to convert an adjustable-rate mortgage to a fixed-rate loan. Or you may be weighing a cash-out refinance to tap equity for repair or renovation projects. Refinancing may be necessary after divorce if you need to remove a former spouse's name from the original mortgage.
Conduct a break-even analysis to compare refinancing costs against potential monthly interest savings as a starting point for making a decision. The break-even point is where you recoup what you spent on refinancing closing costs in the form of money saved in interest and monthly payments.
For example, assume it's going to cost you $3,000 to refinance your mortgage and doing so lowers your mortgage payment by $150 each month. Divide $3,000 by $150, and you get 20, which represents the number of months you'd need to recoup closing costs with mortgage savings.
If you plan to move within a year or two of refinancing, you may not see any return from lowering your interest rate, depending on where your break-even point falls. If you plan to stay in the home long-term, look at the lifetime savings.
Factor in what you've paid on the loan already, your new mortgage rate, your monthly payment and the new mortgage term. Say your original mortgage was $300,000 with a 30-year term. Your starting interest rate was 4.25%, and you're 10 years into your loan.
Refinancing into a 20-year term at 4% would trim $28 per month off your payment. But it would cost you an additional $1,827 in interest, compared with your current mortgage terms. You'd see a small monthly savings, but none where your interest is concerned.
Now, assume that you're only five years into the same mortgage term, and you decide to refinance into a 20-year loan at 4%. In that scenario, your monthly payment would go up by $178, but you'd save more than $4,000 in interest over the life of the loan. Running different scenarios through a refinance calculator can help you decide whether refinancing makes sense for you.
Think about the type of loan term you're planning to refinance into.
"A large savings can be realized if you reduce your term of the loan," Dustman says. "The flip side to this is that if you extend your term for several years beyond the maturity today, even at a lower rate, you may end up paying higher interest over the longer period of the loan."
[Read: Best Mortgage Refinance Lenders.]
Can You Refinance Without Closing Costs?
Refinancing with no closing costs is possible.
"With a no-cost refinance, the lender essentially covers the closing costs rather than having to pay them yourself," Walsh says. "In return, you will generally pay a higher interest rate."
No-closing-cost refinancing could be an advantage if you need to refinance but don't have a lot of cash to cover closing costs. You should consider how such a loan could affect the amount you pay over the long term, though.
A higher interest rate means more interest paid over the life of the loan, even if the difference in the rate is only fractional.
Say you refinance a $200,000 mortgage balance into a 15-year term. You could pay a 4% rate, with $4,000 in closing costs paid out of pocket, or 4.25% with a lender credit for closing costs.
If you opt to accept the higher rate, you'd hang on to your $4,000 for closing but pay about $4,500 more in interest at the higher rate, an overall higher cost of $500.
The other scenario to consider is having the closing costs rolled into the loan in lieu of a higher interest rate. In that case, your rate may not increase, but adding closing costs to the loan means a higher loan amount. That could raise your monthly payments, and you'd be paying interest on the closing costs over time.
[Read: Best Mortgage Lenders.]
How to Save Money on Mortgage Refinancing
There's always a question of whether the costs of mortgage refinancing will outweigh the benefits. But there are some things you can do to reduce the cost of refinancing.
Improve your credit score. Your credit score is one of the most important factors lenders consider when you apply for mortgage refinancing. Along with your income and other financial details, it can determine whether you're approved for refinancing and the interest rate you'll pay.
The higher your score, the lower the rate you may qualify for, which could mean you'd pay less interest to refinance. The most important factors for boosting your credit score are payment history and credit utilization -- how much of your available credit you're using.
Paying your bills on time each month and lowering the balances on your credit cards could add points to your credit score, which could make you a more attractive candidate for refinancing.
Compare lenders carefully. Every lender is different when it comes to rates and terms for refinance loans, so shop around to find the best loan options for you.
Start with your bank or credit union, but get rate quotes from other financial institutions, including online lenders. Zero in on the rates lenders offer for different types of refinance loans and the fees associated with each one.
Check your bank for refinance discounts. Some banks may offer an incentive to customers to encourage refinancing -- a discount or waiver of certain fees. For instance, your bank may cut you a small break on your interest rate or not charge a loan origination fee.
Check your bank's website or call your nearest branch to find out about any special promotions for refinancing.
Negotiate refinance fees if possible. Once you've chosen a loan, don't accept closing costs at face value. Reach out to your lender to see whether any costs associated with refinancing are negotiable.
Some, like local recording fees or property taxes that must be prepaid, may be set in stone. But others, such as the application fee or credit check fees, may be up for discussion.