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Carefully evaluate all the costs involved in refinancing and make sure the savings will outweigh them.
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Refinancing your mortgage can offer many benefits under the right circumstances.
You may be able to lower your interest rate, pay off your loan faster, or take cash from your home.
Refinancing might not make sense if you plan to move soon or your credit score has worsened.
If you buy a home with a mortgage, there will likely come a time when you’re faced with the question of whether or not to refinance. This strategy, which essentially replaces your existing loan with a new one, can help you achieve a variety of financial goals. It might even reduce your monthly payments or interest rate, as long as it’s used under the right circumstances.
Here are a few scenarios in which refinancing might make sense — and some when it may be ill-advised.
What is a mortgage refinancing?
Refinancing is when you take out a new mortgage and use the money to pay off your old one. The new loan may have different terms or a new interest rate. It could even be an entirely different type of mortgage.
Cash-out refinancing is also an option. This involves taking out a new mortgage that’s larger than your current one. The new loan pays off the old one, and you get the difference between the two balances back in cash. Many homeowners use cash-out refinancing to cover the costs of home repairs or renovations.
As Mike Tassone, co-founder of mortgage marketplace Own Up, explains: “The purpose of this type of refinancing is to take additional cash out at closing by borrowing against the equity in your home and increasing the principal balance.”
7 reasons to consider refinancing your home
Refinancing your mortgage can often be a smart move — but only in the right circumstances. It’s important to weigh the costs, your goals, and your unique financial situation before deciding to refinance.
Here are seven scenarios when you might want to consider refinancing:
1. You can get a lower interest rate
One of the best reasons to refinance is to reduce your interest rate, which could save you a lot of money in the long run.
Tassone recommends aiming for at least a quarter-point reduction, though the lower the rate you qualify for, the more you’ll stand to save.
Keep in mind that interest rates are determined both by the market and your credit profile. Borrowers with the highest credit scores will typically qualify for the lowest rates. If your credit score is on the lower end, you might want to take some time to improve it before applying to refinance.
Quick tip: Shopping around for a mortgage lender can help you find a lower rate too. You should get quotes from at least five different lenders and compare the rates, fees, and terms.
2. The value of your home has risen
Refinancing when your home’s value has increased offers two benefits.
First, it might allow you to cancel mortgage insurance. Most conventional mortgages require borrowers to pay for mortgage insurance until they’ve reached at least an 80% loan-to-value ratio — meaning their mortgage loan amounts to 80% or less than the home’s value. If you’re able to refinance into a new loan without mortgage insurance, it could save you both on your monthly payment and in the long haul.
A higher home value also means you have more equity, which would give you access to more money in a cash-out refinance. If your home value is up and you’re looking for a way to cover the costs of a big repair or some other expense you’re facing, a cash-out refinance could be an option to explore.
3. You want to pay off your loan faster
Refinancing lets you take on a new loan with new terms. Tassone calls this, “reworking your loan to better suit your current needs.”
For example, if you wanted to pay off your loan faster, you might refinance from a 30-year loan to a 10- or 15-year one. This would usually mean higher monthly payments, but it would also save you on long-term interest and help you pay off the mortgage faster.
4. Your credit score has improved
Credit scores play a big role in mortgage financing. Lenders use your score in setting your interest rate. It also helps determine the types of loans and terms that are available to you.
If your score has improved considerably since taking out the initial loan, “You may be able to qualify for more favorable terms,” says Mayer Dallal, managing director of mortgage lender MBANC.
Quick tip: Getting your credit score for free is easy. Credit card companies often provide it on your monthly statement or anytime you check your account online.
5. You want to eliminate mortgage insurance
Most FHA loans come with mortgage insurance — typically for the life of the mortgage. It costs anywhere from 0.45% to 1.05% of your loan amount per year.
If you have an FHA loan and want to eliminate those added costs, refinancing into a conventional loan is an option. Your loan balance just needs to be 80% or less of your home’s total value.
6. You have an adjustable-rate mortgage
With an adjustable-rate mortgage, your interest rate can rise over time — meaning your monthly payment can increase. To avoid this, you could refinance into a fixed-rate mortgage, which offers a consistent interest rate and payment for the life of the loan.
Quick tip: If you have an adjustable-rate mortgage, talk to your loan servicer about when your rate may adjust next — and by how much. This can help you determine the best time to refinance your mortgage.
7. You’re facing big expenses or want to pay off debt
Cash-out refinancing can help you pay for renovations, big medical bills, college tuition, or other expenses. It can also help you eliminate higher-interest debts — like credit cards, which currently carry rates over 16%, according to the Federal Reserve.
“With the average mortgage refinance rate just a fraction of the average credit card interest rate, cashing out to be able to pay down your credit card or other higher-interest-rate debts may be a smart financial move,” says Al Murad, executive vice president of sales at AmeriSave Mortgage.
When you use a cash-out refinance to pay off higher-interest debts, you essentially roll those debts into your mortgage loan and then pay them off over time.
7 reasons refinancing your home might not make sense
Refinancing has its benefits, but it’s not right for everyone — nor for every situation. In some cases, it may even cost you more in the long run.
Here are seven times refinancing might not be the wisest move:
1. Fees and other costs would offset the savings
There are closing costs associated with refinancing. In 2021, the average cost to refinance was just under $2,400, according to data compiled by CoreLogic, though it varies by location and lender. According to the Federal Reserve, it can sometimes cost as much as 6% of the loan amount.
For refinancing to be worthwhile, you’d want to make sure the savings would outweigh those initial costs in the long run. As Dallal explains: “Closing costs can be high, so it may not always be worth the time and effort to refinance a mortgage.”
You can use Personal Finance Insider’s mortgage calculator to get an idea of how much a refinance could save you over time. Then, compare that to average closing costs in your state to see if the move is worth it.
2. You might move soon
To come out on top, you want to stay in the home long enough to hit your breakeven point — or the point at which you saved more than the refinance initially cost you.
“Refinancing is generally a bad idea when there are negligible payment savings and the time it would take to break even on the closing costs extends beyond the time you expect to remain in your home,” Tassone says. “You need to be certain that you’ll be in the new mortgage for a long enough time period that the savings exceed the upfront cost to refinance, which can be in the thousands.”
3. Interest rates are significantly higher
If refinancing your mortgage loan would mean trading a low interest rate for a higher one, proceed with caution. There may still be reasons to do it, but you’ll want to weigh the long-term costs of the move first.
To gauge what current mortgage rates look like, see Freddie Mac’s Primary Mortgage Market Survey. You can then use a mortgage calculator to compare the long-term costs of your current loan versus a potential refinance.
4. You’ve had your loan a long time
Mortgage loans are amortized, meaning you pay more toward interest at the beginning of the loan and then more toward your principal balance later in the term. For this reason, refinancing when you’re well into your term can be a big setback. It means resetting all that progress you made and starting over — with the majority of your payments, once again, going toward interest.
“When refinancing into the same product as your existing loan, it’s important to understand that your amortization period will be reset,” Tassone says. “This can lead to paying more in total payments and interest.”
The only reason you might want to take this approach is if you are struggling to make your payments. In this scenario, refinancing into another 30-year mortgage would spread your costs out over a longer period and lower your monthly payment.
5. You can’t afford the closing costs
Refinancing has its costs. Though some lenders advertise “no-cost” refinances, these just roll the closing costs into your mortgage balance. That means higher payments and more interest costs. These loans also come with higher interest rates.
While Tassone says this isn’t always necessarily a bad thing, he stresses the importance of calculating the added long-term costs of such a move and making sure it aligns with your budget and goals.
6. Your credit score is lower than it was before
“If accumulating credit card debt or other factors have caused a homeowner’s credit score to drop significantly since the time of their current mortgage’s lock, it may not be wise to refinance,” Murad says.
A lower credit score will typically mean a higher interest rate and less favorable loan terms than you currently have. If you want the lowest possible rates, most lenders want to see a credit score of 740 or higher.
7. Your current loan has a prepayment penalty
Some lenders charge fees if you pay off your loan too early (usually within three to five years of taking it out). These are called prepayment penalties.
Always check your loan paperwork or ask your servicer if your mortgage has a prepayment penalty and, if so, how much it is and when it applies. Prepayment penalties can not only make refinancing more expensive upfront but also eat into the savings it can net you in the long run.
How to determine if refinancing is worth it
Something you can do to figure out if refinancing makes sense for you is to calculate how long it will take you to break even.
For example, say you originally had a monthly mortgage payment of $2,000, and you refinanced into a mortgage with a $1,800 monthly payment. That means you’re saving $200 a month with your refinance.
To determine your breakeven point, divide your closing costs by your monthly savings. So, if you paid $6,000 in closing costs on your refinance, you’d divide that by $200.
6,000/200 = 30
This means it would take 30 months, or two and a half years, for you to break even on your refinance. If you think you might not stay in the home for that long, refinancing likely doesn’t make sense. But if you plan on sticking around long term and refinancing can help you save money or achieve other goals, you might want to consider it.
How long does it take to refinance a mortgage?
Refinancing typically takes around 49 days, on average, from application to closing, according to data compiled by ICE Mortgage Technology.
To get started, apply for quotes from at least three to five lenders. They’ll give you loan estimates, which break down the terms, rate, and costs, which you can then use to compare against your other offers.
Once you’ve chosen a lender, you’ll complete their full application, submit various financial documents such as tax returns and bank statements, and schedule a home appraisal. When those steps are complete, you’ll be given a closing date, which is when you will sign the final paperwork and pay your closing costs.
If you’re confused about refinancing, you might consider speaking to a mortgage broker. They have access to loan products from dozens of different lenders and can shop around on your behalf.