Mortgage refinance options: How to choose the right one

Nothing lasts forever, and that includes your mortgage. Your financial circumstances may change over time, especially over the many years or decades it takes to pay off a home. It’s not uncommon for your mortgage to fall out of sync with your financial goals and abilities over time, and when that happens, it may be time to consider your mortgage refinance options. 

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In addition, refinancing can help you cut free from burdensome mortgage insurance payments with some loans and take advantage of falling interest rates to get a cheaper home loan overall.   

What is mortgage refinancing?

The basic idea of a mortgage refinance is simple: you take out a new mortgage to pay off your old one. Depending on your goals, your new mortgage may come with a different interest rate, term length, or loan amount. Mortgage refinancing is very common; nearly a third of all mortgage debt was refinanced between the years of 2020 and 2021 alone when homeowners could take advantage of record-low interest rates to lower their monthly payments and save money. 

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Here are the specific reasons many homeowners choose to pursue different refinance options:

• Pay off debt sooner: If you can refinance for a shorter term length and/or a lower interest rate, you may be able to pay off your debt years ahead of schedule. Alternatively, you can simply pay more toward your current mortgage. 
• Save money on interest: Along with paying off debt sooner, you may be able to save thousands on interest over the life of your mortgage if you choose a shorter term length and a lower rate. 
• Lower monthly payments: If you refinance for a longer term length, or if you qualify for a lower interest rate, you may be able to shrink your payments and make them more affordable. This helps many people avoid foreclosure.
• Borrow against home equity: Many lenders allow you to take out a mortgage that’s larger than your current balance, in which case you’d receive the extra proceeds after loan closing. 
• Remove mortgage insurance: Some types of mortgages, such as FHA loans, require certain borrowers to pay an extra mortgage insurance premium (MIP) for the life of the loan — unless they refinance, typically when they reach 20% equity in the home. Other lenders may require private mortgage insurance (PMI) if a borrower has put down less than 20% of the home's value upon purchasing.‍
• Standardize monthly payments: Many borrowers opt for adjustable-rate mortgages (ARMs) for their lower initial rates but become frustrated by ever-changing monthly payments. Switching to a fixed-rate loan can help even out your monthly cash flow. 

Types of mortgage refinance options

You had several mortgage options available when you first bought your home, and the same is true of refinancing as well. Here are the different mortgage refinance options commonly offered, and how to use them to meet your specific refinancing goals:

Cash-out refinance

A cash-out refinance loan replaces your current loan with a larger one. You’ll receive the difference back in cash after closing, and you can use these funds for a variety of purposes, such as retrofitting your home to age in place or paying off higher-interest debt.  

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If you can qualify for a lower rate on a cash-out refinance loan than what you’re paying on your current mortgage, you can meet two objectives at once: scoring a lower rate on your home loan, and borrowing funds for a much-needed use. Otherwise, it may be better to choose something like a home equity loan that allows you to tap into your home equity while keeping your current low-interest mortgage in place.  

Rate-and-term refinance

Most people opt for a simple rate-and-term refinance, which is exactly what it sounds like: replacing your current mortgage with a new one featuring a different rate and/or term length. This can be a good option if you have better credit now than when you first took out your mortgage; doubly so if you’re currently in a low-interest-rate environment. 

Government-backed mortgage refinance

Individual lenders may offer refinance loans backed by the VA, FHA, and USDA, and these can come with a lot of benefits. Lenders who partner with the VA, for example, can offer cash-out and rate-and-term refinance loans to eligible veterans and active-duty service members, often for lower rates than they may get with a conventional refinance loan. 

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Furthermore, these refinance options may be available in a streamlined format, allowing you to qualify without a credit check or appraisal. If your credit score has gone down or you don’t want the extra hassle of getting an appraisal, these can be especially attractive options. 

Who’s eligible for a mortgage refinance?

To qualify you for a mortgage refinance, most lenders will evaluate you based on the same factors as your first mortgage. It’s a good idea to take note of your qualifications in these areas in advance so that you know whether you’re likely to qualify with a specific lender or not. Here’s what mortgage refinance lenders consider:

• Credit score: You’ll generally need a credit score of at least 620, although a credit score of 580 may be sufficient for some government-backed home refinance options. 
• Employment situation: There aren’t any hard-and-fast numbers here, but most lenders are looking for applicants with strong and consistent income from regular employment.
• Loan-to-value (LTV) ratio: Most refinance lenders allow you to borrow up to 80% of your home’s value, meaning you’ll need at least 20% equity in your home to qualify. 
• Debt-to-income (DTI) ratio: Your total monthly debt payments — including your mortgage — will generally need to be less than 45% to 50% of your take-home pay. 

How to refinance your mortgage

In many ways, refinancing your mortgage isn’t too different from when you first bought your home. It may even be simpler, in fact, since you’re not juggling a home purchase at the same time. Here’s how it works:

1. Compare lenders

Most mortgage lenders also offer mortgage refinance options. The approval requirements may vary among lenders, however, as well as your options for term lengths, rates, and fees. It’s important to take your own qualifications into account when shopping around, as well as which features are important for you. 

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You can get a better idea of whether you’re likely to qualify — and for which rates and terms — by getting preapproved with several lenders. This generally uses a soft credit check which won’t impact your credit score but can offer you better insight when comparing your options among lenders.

2. Submit an application

Once you find a lender you like, you’ll need to submit a full mortgage refinance application. If you already applied for preapproval, you’ll generally only need to provide a few more details as well as documentation proving your identity, homeownership, and financial situation. Most lenders require a recent copy of these documents:

• Pay stubs
• Tax returns
• W-2s or 1099s
• Government-issued ID
• Homeowners insurance declaration page
• Bank and investment account statements
• Loan payoff statement from current mortgage lender

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Keep a close eye out for any communications from your lender after you submit your application. You may need to provide other documents and schedule an appraisal for your home, and responding quickly can speed up the loan process. 

3. Get underwritten and approved

Some lenders require a comprehensive appraisal from an assessor who visits your home. Check with your lender how the appraisal will be done, and prepare for the appraisal in advance if needed. 

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It may take your lender several days or even weeks to process all of the different parts of your application, so stay patient until you receive a final decision. 

4. Complete the mortgage refinance closing process

If you’re approved, you’ll need to attend a closing in order to go over and sign the loan documents. Your lender will send you a closing disclosure a few days in advance to review; make sure you read through it and take note of any questions. You’ll also need to pay any upfront fees that you won’t be rolling into your new loan. 

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After you sign the loan, you’ll have a three-day grace period where you can withdraw from the loan if you change your mind. After that, your new lender will send the funds to your old lender to pay off your prior mortgage. If you took out a cash-out refinance loan, you’ll receive the funds deposited into your account. Remember to set up autopay with your new lender and verify that your old mortgage has been paid off. 

Alternatives to a mortgage refinance

Refinancing your mortgage is only one of the many tools available to meet different financial goals. If you’re looking to lower your monthly payment, here are a few other options to consider that don’t require taking out a new loan:

• Remove PMI: Lenders are required to remove PMI charges once you reach 22% equity in your home — but you can proactively file to remove it sooner when you hit 20% equity.
• Mortgage recast: If you can pay a lump sum toward your mortgage, you can request your lender to recalculate your monthly payments based on the new lower balance.
• Loan modification: If you’re facing a financial need, some lenders offer ways to help you repay your loan, such as by lowering the interest rate or extending the loan term.

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If you’re considering a cash-out refinance as a way to borrow money, consider whether one of these other options might work better:

• Non-equity debt: Check whether a credit card or personal loan would be more appropriate. There are also loans for specific uses, like buying a car or going to college.
• Home equity loan: If you need to borrow a lump sum for something like renovating your home but don’t want to replace your current mortgage, consider a home equity loan.
• Home equity investment (HEI): HEIs are different from traditional debt, but you can receive a lump sum of cash now in exchange for a slice of your home equity at a future date.  
• Home equity line of credit (HELOC): Similar to a home equity loan, except you can access funds as needed. A HELOC offers more flexibility but comes with extra costs.

Is a mortgage refinance a good idea?

It’s important to consider your goals for refinancing your mortgage since this will dictate which refinance options are best for your situation. If you’re looking to save money on interest, for example, refinancing for a lower rate is your best option — but not necessarily if you also choose a longer term length, in which case you’ll be paying interest for a lot longer. 

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It’s best to use a mortgage refinance calculator when considering your options, paying close attention to your monthly payment and the total interest you’ll owe over the life of the loan. This will give you a true picture of whether a mortgage refinance is a good idea for your exact situation.