Should I Refinance My Mortgage? (And When Is the Best Time to Do It?)

Unless you had the resources to buy your home using cash, you probably needed a mortgage before you could finalize your property purchase. As a result, you continue to pay your lender a regular monthly amount with the understanding that you’ll be covering both the principal cost of the loan and the interest the lender charges for their services. Throw in additional costs such as property insurance and taxes, and that monthly payment can get pretty steep.

Refinancing your home allows you to secure a loan that better aligns with your goals, whether that’s lowering your interest rate, changing your term or turning your home’s equity into cash. While refinancing can be a major advantage in many circumstances, it isn’t always the answer.

Before refinancing, it's important to understand how it works and the potential drawbacks. Let's take a closer look at what refinancing entails so you can make the best decision for your needs.

Understanding the Reasons to Refinance Your Home

If you’re not satisfied with your current mortgage, or you feel like you could do better, then refinancing may be the answer. When you refinance, you’re essentially trading in your previous loan for a new one — and then using your new loan to pay off the old one. What are the advantages of switching out one mortgage for another? Well, that all depends. There are several good reasons for wanting to refinance your home, including the following:

Capturing Lower Interest Rates

One of the most common reasons homeowners refinance is to secure a mortgage at a lower interest rate. Additional taxes and insurance costs aside, your mortgage has two primary components: the principal and the interest.

• The principal is the amount that you originally borrowed from the lender
• The interest is the percentage of your loan amount the lender charges for borrowing money to purchase a home

The interest is determined by several factors, including:

• The state of the economy and other economic indicators
• Your credit score
• Property type
• The loan-to-value (LTV) ratio

Because any of these factors may change over time, savvy homeowners who wait for the right conditions can refinance by applying for a new loan at lower interest rates and then using that loan to close out the previous loan. If done correctly, this can mean a significantly lower overall amount you’ll pay toward your mortgage.

Shortening Your Loan Term

The sooner you can pay off your mortgage, the sooner you can start increasing your wealth. Without the demands of loan payments, you’ll likely find that your paycheck, savings and investments go a lot further.

Refinancing to a shorter mortgage term, such as from a 30-year to a 15-year loan, can help you pay your mortgage faster and enjoy substantial interest savings throughout the loan term. Plus, if you refinance at a lower interest rate, you may not experience a significant increase in monthly costs.

Changing Your Mortgage Type

Many homeowners choose to refinance to a different mortgage type. Some of the most popular options are detailed below.

ARM to Fixed-Rate Mortgage

Adjustable-rate mortgages (ARM) offer lower initial interest rates for a predetermined introductory period (usually 5-10 years). However, once that period ends, the rates adjust to reflect the market conditions more accurately. While ARMs might make sense for those who want to build equity faster or plan to move before the introductory term ends, many ARM holders opt to refinance to a fixed mortgage. This way, they can avoid dealing with the uncertainty of variable rates and the potential of having to pay more than they can afford once the rates start to jump.

An advantage of switching to a fixed-rate loan is that it locks in interest rates for the duration of the mortgage. For example, a 30-year fixed mortgage at 3% would remain at 3% throughout the life of the loan. Compared to an ARM, fixed-rate loans offer stability and (often) lower overall costs.

Fixed-Rate Mortgage to ARM

On the other hand, if trends suggest falling interest rates or a homeowner intends to relocate within a short period, they may wish to refinance from a fixed-rate loan to an ARM.

FHA Streamline Refinance

An FHA Streamline Refinance is a mortgage refinancing program the Federal Housing Administration offers to lower the interest rate and payment for current FHA loan holders. The benefits include a simplified application process, no appraisal required in many cases, lower closing costs and the possibility of not needing to verify income or employment.

FHA to Conventional Loan

Refinancing an FHA loan to a conventional loan may reduce your long-term costs by eliminating the need for mortgage insurance once you have enough equity in your home. It also offers the potential for lower interest rates and monthly payments, which could further enhance your savings.

A Pennymac Loan Expert can help you explore the different loans that could better match your needs.

Accessing Home Equity Funds

If you have enough equity in your home, refinancing can allow you to tap that equity and turn it into cash. A cash-out refinance allows you to replace your current loan with a new, larger mortgage, netting you the difference between the amount borrowed and what you still owe.

For example, if your home is currently valued at $300,000 and you have a mortgage balance of $200,000, your home equity is $100,000. You could then refinance that remaining balance of $200,000 at $250,000, taking the additional $50,000 as cash. This may make sense if you want to consolidate debt, renovate your home or pay for other large expenses.

Factors to Consider Before Refinancing

Refinancing your home can seem very appealing, especially when mortgage rates are low. Still, as with any financial decision, you must consider several factors before taking this big step.

Timing

If you haven’t been in your home long enough to build good equity, or if the market or your current financial situation isn’t at a spot where you’ll be able to secure substantially better rates, then refinancing may not be the way to go. Additionally, if your debt-to-income (DTI) ratio is higher than it was during your initial financing, you may have trouble qualifying for the new loan.

The Amortization Process

Be aware that taking out a new loan can extend the mortgage by restarting the amortization process, such as if you refinance your existing 30-year mortgage to another 30-year one.

For this reason, many homeowners will choose shorter-term loans when they refinance. This way, they won't get locked into another 30-year mortgage on top of the time they may have already invested into their previous mortgage.

In some cases, extending your loan term could be beneficial, primarily if you aim to reduce your monthly mortgage principal payments. However, be aware that this will result in paying more interest over the loan's lifetime.

Your Credit Score

Refinancing may allow you to qualify for more favorable rates if your credit score has substantially improved since you initially financed your home.

On the other hand, if your credit score is lower, you might be looking at unfavorable rates regardless of what the market is doing.

Additional Costs

With every new mortgage, you’ll be looking at new closing costs. These costs can include fees for appraisals, attorneys, title insurance and more. If you don't consider these additional costs or if you refinance your home every time a lower rate presents itself, you might discover that the money you spend on refinancing is more than the amount you save.

When Should You Not Refinance Your Home

Refinancing can be a smart financial strategy, but it’s not for everyone. Run the numbers with a mortgage refinance calculator and consider the following when deciding if it’s a wise choice for you.

When the Costs Outweigh the Savings

When considering refinancing, it’s important to assess whether the savings justify the upfront costs, such as closing fees. To do this, you’ll want to figure out the break-even point — when your monthly savings from reduced payments surpass the costs associated with refinancing. The break-even point will be different for every borrower and depends on how long you plan on staying in your home. However, it is generally advised to break even within approximately two to three years.

If You Plan to Move in the Near Future

Refinancing when you plan to move soon may not be wise due to upfront costs, such as closing fees, that take time to recoup through monthly savings. If you relocate before reaching the break-even point, you could end up spending more on the refinance than you save.

If You Have a Prepayment Penalty on Your Current Mortgage

Refinancing may not be advantageous if your existing mortgage includes a prepayment penalty. These penalties, charged for paying off your loan early, can significantly increase your refinancing cost and may negate the financial benefits of securing a lower interest rate.

Timing Your Refinance Correctly

Financial experts will offer different benchmarks for determining when to refinance; some say you should wait until interest rates fall at least 1% below your current loan rate, while others recommend refinancing when rates are 0.5% below your current rate. But the truth is, there is no perfect rule of thumb for determining when to refinance your home. Instead, you must consider and compare all relevant variables to your current and future needs. Once you’ve run the numbers, you’ll have the insights to decide whether refinancing makes sense for you.

How to Refinance a Mortgage

While refinancing your mortgage is generally more straightforward and quicker than the initial home-buying process, it involves similar steps:

Step 1: Application

Refinancing starts with selecting a loan type and beginning the application process. You’ll need to provide documents like pay stubs, W2s and bank statements. Lenders assess your assets, income and credit score to approve your loan.

Step 2: Locking in Your Rate

Given mortgage rates fluctuate, you can lock in your rate to prevent changes before closing, usually for 30 to 60 days. You might also opt to "float" your rate, accepting the current market rates at closing time.

Step 3: Underwriting and Appraisal

After locking in rates, lenders verify your details and appraise your home to confirm its value, impacting your loan limit. It's helpful to list any property upgrades you've made.

Step 4: Closing

The final step involves reviewing a Closing Disclosure (CD) that outlines your loan's specifics and costs. After reviewing, signing and covering any remaining fees, the deal is almost done. The lender is required to give you the Closing Disclosure at least three business days before you close on the mortgage loan. This three-day window allows you time to compare your final terms and costs to those estimated in the Loan Estimate that you previously received from the lender. The three days also give you time to ask your lender any questions before you go to the closing table.

Refinance with Help From Pennymac

If you’re ready to refinance or want to explore if it’s right for you, Pennymac is here to help. Learn more about refinancing or contact our Loan Experts, who can answer your questions and provide customized guidance.

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