How to decide whether to refinance your mortgage

  • Refinancing a mortgage can be a good way to lock in a lower rate or tap into your home equity.
  • But depending on your circumstances, you may decide it isn’t worth paying the closing costs.
  • To decide whether you should refinance, consider your goals and use a refinance calculator.
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Refinancing your mortgage can be a great way to save money, both in the short-term and long-term. You can swap out your current mortgage for one with a different term length, lower interest rate, and even lower monthly payments.

Refinancing isn’t the best match for everyone, though. It depends on your current financial situation and your goals.

Wondering if you should refinance? Here are some factors to consider when making your decision:

When to refinance your mortgage

1. You have an adjustable-rate mortgage

Adjustable-rate mortgages keep your rate the same for the first few years, then change it periodically, usually once per year.

ARMs used to be helpful for homeowners in certain situations. ARM rates would start lower than fixed rates for the introductory rate period, so if you moved before the rate changed, you could save money. Plus, there was always the chance your rate could decrease later.

But these days, ARMs aren’t very beneficial. ARM rates are starting higher than fixed rates. And mortgage rates are at all-time lows overall, so you could save a lot of money by locking in a super low rate for the entire life of your loan.

If you have a good chunk of time left on your ARM and plan to stay in the home for a while longer, you may want to refinance into a fixed-rate mortgage, which will keep your rate the same until your final payment. Mortgage rates won’t stay this low forever, so you risk a rate increase later if you keep an ARM. But if you refinance into a fixed rate, you could lock in a low rate until you’ve completely paid off your home.

2. You could get a significantly lower rate

If you bought your home a few months ago and see rates are just a smidgen lower now than they were then, you may decide it’s not worth refinancing.

But if you got your initial mortgage years ago, you may be able to lock in a drastically lower rate now — which could save you tens of thousands of dollars in interest over the years. 

3. You want a new loan term

Maybe you want to refinance into either a shorter term or longer term.

Let’s say you have 20 years left on your mortgage, and you refinance into a 15-year term. You’ll pay off your mortgage five years earlier and save a ton in interest. 

Or you have 20 years left on your mortgage and refinance into a 30-year term. By spreading out your payments over a longer period of time, your monthly payments will go down.

Whichever option you choose, just be aware of the pros and cons. Refinancing into a shorter term saves you money in the long run, but your monthly payments will be higher. Refinancing into a longer term lowers your monthly payments, but you’ll pay more over the years.

4. You have big plans for a cash-out refinance

If you’ve gained equity in your home since buying it, you might want to do a cash-out refinance. With this type of mortgage, you take out a loan larger than the amount you still owe, and you receive a portion of your home’s gained value in cash.

A cash-out refinance can be a great tool for achieving other financial goals. Maybe you want to pay down high-interest credit card debt, renovate your home, or go back to school. You can use the equity you’ve gained in your home to cover these costs.

When it might not be a good idea to refinance

1. It would take a long time to break even

Just as with your initial mortgage, you have to pay closing costs when you refinance. According to the Federal Reserve, closing costs typically come to 3% to 6% of your outstanding mortgage balance. So if you refinance into a mortgage with a $100,000 principal, you’d pay $3,000 to $6,000 at closing.

Refinancing for a lower rate can be great, but how long will it take for you to save enough money in interest to cancel out the closing costs?

Darrin English, Senior Community Development Loan Officer at Quontic Bank, told Insider the rule of thumb is that you should only refinance if your new rate will be at least 1% less than what you’re paying now. Another way of looking at it is that you should be able to break even within 2 1/2 years.

“This was actually a Housing and Urban Development rule at one point, and it’s become the standard,” English said. “I’ve been in the business for almost 25 years now, so I just hold it as true, because I’ve seen success.”

Think about the timeline you’re comfortable with, though. You may decide you’re fine if it takes longer to break even, because you plan to stay in this house forever.

2. You would use a cash-out refinance for unnecessary expenses

There are no rules about how you can use money from a cash-out refinance. But because refinancing comes with thousands of dollars in closing costs, it’s probably not financially prudent to refinance to cover frivolous expenses.

Ultimately, it’s up to you which expenses are worth doing a cash-out refinance. Just be sure to weigh the pros and cons before you move forward.

How to decide if you should refinance

Think about your financial goals

Ask yourself why you want to refinance right now.

Do you plan to pay off your mortgage faster? Save in interest over the years? Lock in lower monthly payments?

Figuring out your goals will assist you in choosing your new mortgage terms, which can help you make decisions going forward.

Look at interest rates

How are interest rates now compared to what you’re paying on your initial mortgage? If rates are significantly lower, you may decide it’s time to refinance.

Shop around for lenders to find ones offering the best rates. You can also apply for preapproval with multiple companies to compare more personalized rates.

Consider closing costs

When searching for the right lender, ask each one for an itemized list of fees. This way, you can see how much you’ll pay in closing costs with every company. 

If you find a lender with a great rate and relatively low closing costs, you may have found your fit.

Take stock of your finances

Ideally, you’d be in a good financial situation when you refinance, for two reasons.

First, lenders reward people with stronger financial profiles with better interest rates. If you have a good credit score, low debt-to-income ratio, and a hefty chunk of equity in your home, you could get a great rate. But if you’re lacking in these areas, you probably won’t get the rate you’re hoping for.

Consider beefing up your finances before refinancing, if necessary. Be sure to make all your payments on time to boost your credit score, or aggressively pay down some debts.

Second, you want to make sure you can afford the closing costs. You don’t need to take on a financial burden you aren’t ready for.

Use a refinance calculator

Want to figure out how much you’d save by refinancing? Try using an online mortgage refinancing calculator through websites like NerdWallet and Bankrate. You’ll see how much you’ll save in the long run and what your new monthly payments would be. Seeing the numbers can help you make a decision.

Laura Grace Tarpley is the associate editor of banking and mortgages at Personal Finance Insider, covering mortgages, refinancing, bank accounts, and bank reviews. She is also a Certified Educator in Personal Finance (CEPF). Over her four years of covering personal finance, she has written extensively about ways to save, invest, and navigate loans.

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