When should you refinance your mortgage?

Many choose to refinance a mortgage to lower monthly payments, pay off the loan faster or tap home equity for cash. Borrowers tend to think about refinancing when interest rates are sinking or stable — but the current environment has been anything but. Still, swapping your old home loan for a new one now could make financial sense for you. Read on to learn when to refinance a mortgage and when it might be better to consider other options.

When should you refinance your home?

When deciding if refinancing is right for you, consider current mortgage rates. The math isn’t as simple as comparing the interest rate you locked in when you were approved for your mortgage versus the rate you can qualify for now. There are several kinds of refinance options out there, each with unique pros and cons. Review this trio of factors from Bill Packer, chief operating officer of reverse mortgage lender Longbridge Financial, LLC, as you consider each:

1. The after-tax monthly savings (new payment compared to old payment, after any tax-favored treatment)
2. The amount of time that you intend to be in the home
3. The cost of obtaining the new mortgage

Once you know these three things, you can calculate your return and see if it is positive, says Packer.

Reasons to refinance your mortgage

For many borrowers, it’s a good idea to refinance if you can lower your interest rate and plan to stay in your home long enough to recoup the refinance closing costs.

Here are the key reasons to consider refinancing:

Lower your interest rate

If interest rates have dropped since you first obtained your mortgage, a rate-and-term refinance can provide you with a lower rate. Ideally, that rate should be one-half to three-quarters of a percentage point lower than your current rate.

You might also qualify for a better interest rate if your credit score has improved since taking out your current loan. The best mortgage refinance rates go to those with a score of at least 740, however, so check your credit report before applying.

Pay for large expenses

You can do a cash-out refinance to tap your home’s equity for cash. These funds can be used for any purpose, such as:

• Lowering or paying off high-interest debt
• Renovating your home
• Paying college tuition
• Investing in property

Eliminate private mortgage insurance (PMI)

If your home’s value has increased, you could refinance your conventional loan to get out of paying private mortgage insurance (PMI) sooner than what your repayment schedule lays out.

Change your loan structure or term

If you’re not far into repaying a 30-year mortgage and want to pay it off sooner, you could refinance to a shorter loan term, such as 15 years. This will save you money on interest, as well.

Likewise, if you have an adjustable-rate mortgage that’s about to convert to the variable-rate period, you could refinance to a fixed-rate loan to guarantee predictable monthly payments.

When not to refinance

Generally, it might not be smart to refinance for any of these reasons:

• Splurging on discretionary purchases: Don’t fall into the trap of putting your home on the line to spend the refinance savings or cash-out proceeds on discretionary expenses like a vacation. In general, it’s better to save for these costs.
• Moving into a longer-term loan: If you’re already at least halfway through the loan term, it’s unlikely you’ll save money refinancing. You’ve already reached the point where more of your payment is going to loan principal than interest; refinancing now means you’ll restart the clock and pay more toward interest again.
• Paying off your home faster if you don’t have savings: You could shortchange yourself by using funds that could otherwise be spent on more pressing financial goals: building an emergency fund or retirement savings, for example.

How much does it cost to refinance?

Refinancing could save you money in the long run, but it comes with closing costs that vary by your location, lender and other factors. These fees can run anywhere from 2 percent to 6 percent of your new loan balance.

Rather than pay all that money upfront, many lenders allow you to roll the closing costs into your principal balance and finance them as part of the loan. Keep in mind, though, that adding those costs to the loan only increases the total amount that will accrue interest, ultimately costing you more.

How much can I save by refinancing?

The amount you can save by refinancing depends on several factors, including your closing costs. If you refinance to a $250,000 loan and the closing costs total 2 percent of that, for example, you’d owe $5,000 at closing. You won’t begin to reap the benefits of a refinance until you reach the break-even point — when the amount that you save exceeds the amount you spent on closing costs.

To determine the break-even point on your refinance, divide the closing costs by the amount you’ll save each month with your new payment.

Let’s say that refinancing will save you $150 per month, and the closing costs on the new loan are $4,000.

So, if you were to close your new loan today, you’d officially break even just over two years and two months from now. If you live in the home for five years after refinancing, the savings really start to add up — $9,000 total.

You can use our refinance break-even calculator to figure out how long it will take for the cost of a mortgage refinance to pay for itself. If you think you might sell the home before your break-even point, refinancing might not be worth it.

Example: Deciding when to refinance a mortgage

Let’s say you took out a 30-year mortgage for $320,000 at a fixed interest rate of 6.23 percent. Your monthly payment would be $1,966. Over the life of that loan, you’d pay about $707,901, which includes $387,901 in interest.

Now say about 15 years into the loan, you’ve paid $86,551 toward the principal and $257,499 in interest and you want to refinance the remaining $233,449 of your principal balance with a new 15-year fixed-rate loan at 5.11 percent.

The new loan would trim your monthly mortgage payment to $1,859 per month, giving you an additional $107 of wiggle room in your monthly budget. Over the life of the loan, you’d pay $334,756, of which $101,307 would be interest. Add in the $344,050 in principal and interest you paid on the previous mortgage, and your total cost will be $678,806.

By refinancing, you’d not only lower your monthly payments — you’d see a long-term savings of about $30,000.

Is refinancing worth it?

If it frees up money in your monthly budget, reduces the overall cost of the loan or helps you achieve some other financial goal, refinancing can be well worth the work and money.

“It’s important to determine your break-even point,” says Linda Bell, senior writer for Bankrate. “Remember that refinancing has costs just like a regular mortgage. While your goal might be a shorter loan term or a lower interest rate, if you plan to sell your home in a few years, it might not make financial sense. Make sure the benefits outweigh the costs.”

Mortgage refinance FAQ

• How does refinancing a mortgage work?

  Refinancing a mortgage involves swapping out your current home loan for a new one, often with a different rate and term. The process is similar to when you initially purchased your home. Refer to our mortgage refinance guide to learn more.
  

• How soon can you refinance a mortgage?

  How soon you can refinance a mortgage varies by the loan type. Some lenders require you to wait at least six months to refinance a conventional loan, particularly if you are seeking to refinance with the same lender, while others might let you refinance with no waiting period. Government-backed loans each have their own requirements, so check with your lender on waiting periods to refinance.
  

• Is now a good time to refinance?

  It depends on your mortgage product and financial situation. To decide if the time is right, conduct a cost-benefit analysis to learn when you’ll break-even. Consider using our mortgage refinance calculator to get an idea of potential cost-savings (or losses).