How to Refinance Your Mortgage: Step-by-Step Guide

When interest rates dip low, refinancing the mortgage on your investment property becomes immensely attractive. But you might wonder:

• How to refinance your mortgage? 
• What steps are involved? 
• How much does it cost? 
• Should you even get a refinance loan? 

While the concept of refinancing may not be too complicated—you’re simply changing the terms of your mortgage to more favorable conditions—there’s a lot more under the hood than you’d expect.

Aligning your goals in both the long term and the short term is crucial when refinancing, which requires more in-depth knowledge of the various factors involved—discount points, amortization, private mortgage insurance, interest rates, how credit scores impact your terms, and more.

Regardless of your current position, refinancing can be a great way to reduce your monthly payment and create extra leverage in your business. In this guide, we’re going to talk about everything you need to know when it comes to refinancing your mortgage.

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What Is Mortgage Refinancing?

Mortgage refinancing involves replacing your current mortgage with a new mortgage with better terms and rates. This especially is helpful for adjustable-rate mortgages when the rate begins to increase. 

For instance, if you own a property backed by a 30-year loan with an adjustable 4% interest rate, your monthly payments are subject to change based on fluctuating interest rates. By refinancing, you can switch your mortgage loan to a fixed-rate mortgage at 3%, which lowers the total interest over the life of the loan, meaning lower, consistent monthly payments. That makes budgeting a lot easier.

There are many ways to refinance. A popular method for investors is a cash-out refinance, where you take out a mortgage worth more than you owe on the property. This gives you extra cash to use as a down payment on another investment or make improvements on your existing property. 

But first, let’s cover the basics of the refinance process.

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How Does Refinancing Work?

The refinance process can be summed up into five primary steps:

1. Prepping
2. Choosing a lender
3. Locking your rate
4. Underwriting
5. Closing

Prepping for a refinance

When you’re getting ready to refinance, know that whatever lender you choose is going to want to learn about your overall financial health, including income, debts, assets, and credit scores. Documents you might need to present include:

• W2 forms
• Pay stubs
• Bank statements

This varies by lender. If you’re self-employed, a business owner, or an investor—or a mix of these roles—be ready to present additional documents, like tax returns or any leases on the property.

You’ll also want to take this time to evaluate the current value of your property and see if there’s anything you can do to increase its value. To complete the refinancing process, you’ll have to get an appraisal. By making these changes now, you can create extra equity.

Choosing a lender

There are several different institutions you can approach. Whether you look at banks, financial institutions, consumer finance companies, credit unions, or savings and loan firms, you can find someone that will work with you—assuming that you’re qualified.

The real task when choosing a lender is to compare the offered terms and rates. Interest rates are often similar, but a slight reduction at one bank can save you a lot in the long run. Be sure to diligently sift through potential lenders to ensure you’re getting the best loan.

Locking your rate

Once you’ve selected a lender and they approve you for a new loan, you may be able to lock your rate. This means that you can keep your interest rate at a set percentage for the time it takes the refinance to close. 

This typically takes about 15 to 60 days, although the set time varies by lender, location, and type of loan. If the loan does not close by the conclusion of the lock period, you might be forced to extend it by paying a fee.

Sometimes you can “float” your rate. This means you forgo locking the rate in the hopes that market rates decrease. However, you also run the risk of the interest rate increasing.

Underwriting

After you’ve submitted documents, been approved, and locked or floated your rate, you’ll go through the underwriting process. During this time, an underwriter conducts a deep dive into your finances and verifies all your financial information.

This is also when a property appraisal will be ordered. Underwriters request an appraisal to help them determine whether the loan amount they’re giving you is suitable, but also to help you weigh your options. 

For example, if you’re an investor seeking a cash-out refinance, the appraisal lets you and the underwriter know how much extra cash you can take out. If the appraisal comes back lower than the prescribed loan amount, you can lower the mortgage amount.

You don’t always need an appraisal. For instance, if your conventional loan meets Federal Housing Finance Agency (FHFA) standards for terms and underwriting, you could get a waiver. The lender can simply use past appraisals and market estimates to come up with a value. Still, it might be in your best interest to request an appraisal if you think your property’s value has appreciated since you purchased it.

The lender’s final decision is made during the underwriting process. You’ll either be approved, denied, or suspended by the underwriter. If you’re suspended, they’re most likely missing information that you’ll need to provide. If denied, you’ll be given the reasons for your denial.

But if you’re approved, you’re all set to close.

Closing

This is the final part of the process. Closing on a refinance is faster than closing on a property purchase since you’re avoiding the transfer of deeds, inspections, and other steps involved in a standard purchase. Before closing, you’ll receive your loan estimate and closing disclosure forms. These documents provide you with all the necessary information about your loan and its terms.

At closing, you’ll sign any necessary documents to finalize your loan and pay any closing costs you owe (usually 2% to 5% of the mortgage). The lender will pay you any funds they owe you, such as in a cash-out refinance. After that, your property is refinanced.

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Why Refinance Your Mortgage?

Refinancing isn’t always the right thing to do. It isn’t free, and it requires a lot of paperwork and prepping. Refinancing can be a headache, and it might not change your bottom line much.

However, there are plenty of good reasons to refinance.

Lower your monthly payment

The most obvious reason to refinance is to lower your monthly payments for the life of the loan.

A low refinance rate can make a big difference in your monthly payments. If your original mortgage interest rate is 5% and the market is currently offering 3%, refinancing offers two obvious benefits:

1. Reducing your monthly payments
2. Building more equity

If you’re an investor looking for more monthly cash flow, refinancing is the way to do it.

Reduce the length of your mortgage

It’s possible to reduce the length of your loan through refinancing. For instance, your original term may have been 30 years. By refinancing a home or another property, you should be able to change that to a shorter term of 20, 15, or even five years.

Your payments might increase or decrease depending on the length of the loan’s amortization schedule. Refinancing a mortgage is a good option if you can make the payments and gain more equity on the property faster.

Take cash out

Cash-out refinancing is a popular way for a borrower to take out extra money for personal or business expenses. Investors looking to purchase additional properties can refinance their existing properties to gain the cash to put a down payment on a new property investment.

Another reason you might take cash out is to prevent balloon payments that you agreed to in the terms of your original loan. These payments can catch property owners off guard and present a serious amount of risk to both the loan servicer and you. By refinancing just before your balloon payment(s), you can get extra cash by borrowing more than you owe—and reset the loan with more favorable terms.

A home equity line of credit (HELOC) does not involve refinancing, but it is another way to take cash out using your home equity.

Eliminate private mortgage insurance

Private mortgage insurance (PMI) is required on any property with less than 20% equity. Often, PMI removals are a product of appreciation during mortgage refinancing. If you bought your property five years ago on a full mortgage, you’re probably not past the 20% threshold yet from payments alone. However, due to appreciation, there’s a chance your property’s value has created more equity, meaning you’ll qualify for PMI removal if you surpass 20% in total equity.

Refinancing a mortgage isn’t the only way to remove PMI. Depending on your original mortgage loan terms, you can request removal once your loan trickles down to 80%. You can also set up automatic termination at the 78% mark.

Regardless of how you eliminate PMI, it can potentially save hundreds of dollars from your mortgage bill every month.

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Key Refinancing Terms

Refinancing can be complicated at first. Two key terms that you need to understand are discount points and amortization.

Discount points

Discount points are fees you pay directly to the lender at closing to lower your interest rate. Another way of thinking about discount points is the phrase “buying down the rate.” One point costs 1% of your total mortgage and will generally reduce your interest rate by about 0.25%, although reductions vary.

For example, if you were purchasing a property with a $200,000 mortgage and 4.25% interest, you could buy a point for $2,000 and lower your interest to 4%, saving yourself extra with reduced interest payments over the course of your loan.

Discount points are not always cut-and-dried. Lenders don’t always offer reductions worth taking, so you need to evaluate whether it makes sense to buy points during a refinance. 

Questions you should answer include:

• How much of a financial impact will buying points make?
• Will you break even in saved interest costs?
• Will you keep the property long enough to make it worthwhile?
• When is the interest rate low enough for you?

Amortization

Amortization is essentially the long-term plan for how a loan will be paid off, accounting for interest and principal payments. Amortization loans—a category that includes mortgages—differ from other loan types, like revolving credit, because amortization involves “killing a loan” until it reaches zero.

Once the loan is at zero, you’ll have full equity in whatever asset you used the loan for.

Many investors refinance to change the amortization schedule for their mortgages. This is typically done with a reduced interest rate, which alters the amount of money that goes towards interest each month and increases equity faster.

Alternatively, changing the length of the loan can affect the amortization schedule. This creates larger or lower monthly payments, altering the schedule of amortization.

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What You Should Know Before Refinancing

When considering refinancing a mortgage, look beyond the current interest rates or the enticing idea of lower monthly payments.

There are plenty of reasons to refinance as an investor, but there are many factors to keep in mind before you do so.

The value of your property

Home and property values constantly fluctuate. Lately, home values have been skyrocketing, but that’s not always the case. Most of the time, property owners with more than 20% equity in their investments will have an easier time qualifying for a conventional refinance loan than those who have less.

The reason? The more ownership you have in your property, the less risk for the lender. For one, having higher equity means you’re current on payments and have been for a while. Second, more equity means more collateral if you default. Finally, the lender won’t have to issue as much money, making the risk of loss lower.

Getting an estimate on your current equity can be achieved with an appraisal. Appraisers will determine what buyers would reasonably pay for your property, given the current market conditions. Whatever their evaluation amounts to, you subtract your current mortgage loan. This is now your equity in the eyes of the lender.

If you have less than 20% equity in a property, your options are limited. Your best options are to:

• Wait for appreciation to surpass the 20% threshold.
• Make improvements to earn a higher appraisal.
• Continue to make a monthly mortgage payment on your existing mortgage.

Lenders might ask for even higher equity for investors—likely around 25%. In an economic crisis, lenders assume that investors are more likely to default on rental property loans than their own homes.

Visit a mortgage lender and discuss your path toward refinancing. They’ll help you figure out what conventional loans you qualify for and whether government programs can help you refinance with low equity.

Your credit score

You might know that the higher your credit score, the lower your interest rates. Lenders charge higher interest to those with lower credit scores to protect themselves from losing out if you default. In essence, they want to get whatever they can from you, just in case.

However, ever since the 2000 housing bubble catapulted into the Great Recession of 2008, mortgage lenders have tightened their lending requirements. Nowadays, you’ll ideally want a score above 750 to qualify for the best rates. Keep on top of those payments!

Debt-to-income ratio

Mortgage lenders want to see that your housing debt-to-income ratio is below or at 28% before they qualify you for a new loan. Furthermore, they’re also checking to make sure your total debt is below or at 36% of your monthly income.

Consider paying off extra debt to lower those numbers before attempting to refinance. This will earn you the best rates possible and make refinancing worthwhile.

Long-term plans

If you’re looking to sell your property soon, refinancing a mortgage doesn’t make a lot of sense. Refinancing can cost thousands of dollars, and it may take some time before investors break even in total savings from refinancing.

Furthermore, some loan contracts come with owner-occupancy clauses that require a homeowner to live at the property for a certain period. Read and discuss the terms found in your loan disclosure form with your lender to ensure your goals and intentions align with your mortgage.

Investors most likely won’t be living at their rental properties. Speak with your lender about different conditions for your loan. It might make sense to use a cash-out refinance to finance a new property or improvements, and then sell the refinanced property.

Private mortgage insurance

Any property owner refinancing a property with less than 20% equity will be required to pay PMI.

If you have more than 20% equity—and it will be hard to receive a new loan if you don’t—you don’t have to buy insurance coverage. Eliminating PMI, combined with a lower interest rate, will significantly reduce your monthly payment.

However, let’s say you purchased your property with a large down payment, surpassing 20%. But your home has depreciated, and you no longer have 20% equity (an unlikely but possible scenario). You would then be forced to pay the extra fee for PMI each month, making it important for you to keep tabs on your equity while considering a refinance.

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Types of Mortgage Refinances

There are two primary types of refinances: rate-and-term and cash-out.

Rate-and-term refinancing

Rate-and-term refinancing is the standard process that most people understand: You swap out your current mortgage with higher interest rates for a shiny new one with different terms and lower interest rates.

Generally, these refinances occur nationwide when federal interest rates are slashed, such as when the COVID-19 pandemic broke out in early 2020. Of course, you can refinance at any time that makes sense for your situation.

Cash-out refinancing

Investors favor this type of refinancing due to the leverage it grants. Cash-out refinances allow you to borrow more than you owe to pay off your original mortgage—meaning you can get extra cash at closing that you can use for other investments, debt consolidation, or other personal expenses. 

There is a limit to how much you can take out, though. Depending on your lender, you can take out up to 80% or 90% of your property’s equity. That allows for plenty of leverage.

The obvious drawback to these types of loans is that you have to pay back more than you would have with a traditional rate-and-term refinance because you borrowed more money. However, if the funds received are put to good use, it’s well worth it. Just make sure you’re accounting for closing costs, which are usually 2% to 5% of your mortgage.

HELOCs and home equity loans

These two are not types of refinancing, but they’re often confused with them. HELOCs (home equity lines of credit) and home equity loans are based on the current equity in your property. While lenders differ on what they’ll offer, you can borrow a certain percentage of your equity based on your loan-to-value ratio (LTV).

 If you have a $400,000 mortgage and $200,000 in equity, your LTV is 0.5. That means you can potentially get a loan on your equity of 30%, which would be $60,000.

HELOCs differ from home equity loans in that they’re essentially credit cards. Interest rates are variable, and you’re allowed to borrow whenever you need, up to a certain amount that your lender designates. Home equity loans are lump sums with a fixed rate.

Depending on your needs, the type of loan you should get varies. But they’re not to be confused with refinancing.

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Is Refinancing Right for You?

It depends on your market, economic environment, and financial position. Refinancing makes sense if:

• Interest rates are low.
• You can benefit from reducing your rate.
• You have an adjustable-rate mortgage that gives you no protection against erratic payments.
• Your current loan term doesn’t match your goals.

But refinancing isn’t right for you if:

• You’re not sure if you’ll ever break even after buying down your interest rate and paying for closing costs.
• You plan on selling your property very soon.
• Your financial situation is insecure or unstable.

It’s up to you to evaluate your situation, adjust your goals, and determine whether refinancing makes sense for you. Remember, you can always talk to experienced real estate agents, investors, mortgage brokers, and lenders to get a better sense of your current situation.

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Refinancing FAQs

Is it hard to refinance a mortgage?

Refinancing a mortgage can seem complicated, but it’s a little easier than applying for the property’s initial mortgage, since you already have equity in the property. The best way to start is by talking to your mortgage company about refinancing options and what makes sense for your investment business.

Does refinancing hurt your credit?

Any time you apply for a new line of credit or loan, your credit score will be negatively affected. How much it’s affected depends on your credit history. If you have a good credit report, refinancing will likely only slightly lower your credit score for a short period of time. An investor with lower credit will see a larger dip in their credit score.

How long do you have to have a mortgage to refinance?

Lenders typically like to see investors have at least 25% equity in the property before allowing them to refinance. If you just got your mortgage, your lender may also make you wait six months before refinancing, but you can always find a different lender to refinance with. If you want to do a cash-out refinance, you must have owned the property for at least six months.  

How much does it cost to refinance?

Refinancing an investment property can be a smart financial move, but it’s not cheap. Most investors spend 2% to 5% of the total loan amount on closing costs. For example, if you’re refinancing a loan of $200,000, you’d owe $4,000 to $10,000.  

When should I refinance my mortgage?

The best time to refinance your mortgage is when national interest rates on home loans have significantly lowered. A lower interest rate can lower your monthly payment, helping you save money to use on new properties, repairs, or whatever you like. 

Is it better to refinance or do a loan modification?

A loan modification is more difficult to receive from a lender than a loan refinance. A loan modification changes the terms of your mortgage, such as a different structure or longer loan term. Most lenders only agree to a loan modification if you’re at risk of foreclosure. If you are simply looking to lower your monthly payment or switch to a fixed-rate mortgage, refinancing your mortgage is a better option. 

Can a reverse mortgage be refinanced?

Yes. You can refinance a reverse mortgage into a new reverse mortgage or a traditional mortgage to pay into the property’s equity. If your property equity has gone up or your spouse isn’t on the mortgage, you may want to consider refinancing your reverse mortgage. 

Can you remove someone’s name from a mortgage without refinancing?

No. You’ll need to pay off your existing mortgage or refinance the loan if you remove a co-borrower or cosigner, since the loan was granted on the basis that both names would be responsible for the payments. By taking off one of those names, the bank needs to reevaluate the loan and what the borrower qualifies for.

Can you refinance a fixed-rate mortgage?

Yes, but carefully consider when to refinance your mortgage. The best time to refinance a fixed-rate mortgage is when mortgage lending rates are lower than your current interest rate. Use an online mortgage refinance calculator to see if your monthly payments with a new interest rate would be low enough to make refinancing worth it. 

Can I reduce my mortgage payment without refinancing?

Yes, there are other ways to reduce your mortgage payment without refinancing. The easiest step is to find a lower property insurance premium by shopping around with different insurance providers. You may be able to get the same coverage for a lower amount. 

Property owners who have at least 20% equity in their property can also ask their bank to remove private mortgage insurance (PMI). If you are at risk of not making your loan payments, you can request a loan modification, which will change the terms of your loan.