Power Tips

How to Decide When to Refinance a Mortgage

Published on: January 6, 2022

when to refinance mortgage

Understanding when to refinance a mortgage will help you to reap the most benefits from your home loan. When done right, you can reduce your monthly mortgage payments and save thousands over the life of your loan. You could also tap into your home equity and complete repairs or renovations to help increase the value of your property. 

Before you go through with a refinance, you’ll need to consider several factors that come into play and calculate whether the costs to refinance are worth it.

When is refinancing worth it?

It makes sense to refinance your home when you can achieve your financial goals faster with new mortgage terms. For instance, most homeowners refinance to save money by getting a lower interest rate or shortening their mortgage term to pay off their loan faster.

Benefits of refinancing a mortgage

If you’re wondering when you should refinance your mortgage, consider the following benefits of refinancing:

  • Lower your monthly payments: Refinancing to a new mortgage with a lower interest rate could lower your monthly mortgage payments and save money over the life of your loan. Refinancing to extend the term of your mortgage may also lower your monthly payments, but you may end up paying more in interest.
  • Shorten your mortgage term: Refinancing to a shorter term means you can pay off your mortgage faster. Rates are typically lower with shorter-term loans, so you may be able to save on interest costs, too.
  • Tap into home equity: A cash-out refinance allows you to access the equity you have in your home so you can pay for big-ticket items, such as a home renovation, at a lower rate than an unsecured loan, such as a credit card, would typically offer.
  • Save on interest: If rates have fallen since you bought your home or your credit score has improved, you might be able to refinance to a lower interest rate, which could save you a significant amount over your loan term. Homeowners who have adjustable-rate mortgages (ARMs) may also be able to save on interest by refinancing to a fixed-rate mortgage, especially if they anticipate rates rising with their current loan. Homeowners will also benefit from the security of fixed monthly payments.
Reason to Refinance  Benefits 
Lower monthly payments 
  • Provides more breathing room in monthly budget 
Shorten mortgage term 
  • Allows you to pay off your mortgage sooner, get a lower rate 
Tap home equity  
  • Withdraw cash to fund home improvements and other financial goals
Save on interest or fees
  • Allows you to pay less for your home over the long term  
  • Offers more certainty by moving from an ARM to a fixed-rate loan
  • Eliminates private mortgage insurance (PMI) once you have enough equity

 

Reasons not to refinance your home

Refinancing your home may not be worth it if you intend on moving in the next few years. Since refinances require closing costs, you may not be able to recoup those costs if you move too soon. 

Figuring out the break-even point can help you determine how long you should stay in your home for refinancing to be worth the cost. To calculate this number, divide the closing fees you’ll pay by the amount you’ll save on your new mortgage each month. 

For example, if you’ll have to pay $3,000 in closing costs to nab a savings of $250 off your mortgage each month, your break-even point would be 12 months ($3,000 divided by $250). That means you’ll need to stay in your home for at least 12 months to recoup your closing costs. 

Refinancing to a shorter term means you’re more likely to pay more each month. If you can afford the new payment, you can save a significant amount in interest over your loan. But paying a hefty mortgage could leave you without enough money to save or pay for unexpected expenses. 

You’ll have to review your finances to ensure you’ll be able to qualify for a refinance. Considering the best rates and terms go to those who are the most creditworthy, you’ll want to improve your credit score as much as possible before you apply for a refinance.   

If your credit history reveals some negative marks, such as missed payments, then you may not qualify for the best rates. Lenders also may not consider your application if you have too much debt.

Should I refinance? Top reasons to refinance

The benefits outlined above will help you determine when it makes sense to refinance a mortgage. Other reasons to refinance your mortgage include removing mortgage insurance for qualifying borrowers.

If your current mortgage is a conventional loan and your down payment was less than 20%, lenders charge private mortgage insurance, or PMI, to lower their risk. Lenders are required to remove this charge once your principal balance reaches 78% of your home’s original value. While you can request that PMI is removed sooner if your home value has risen, you can also remove PMI by refinancing.

Some government-backed mortgages, such as FHA loans, require mortgage insurance throughout the life of your loan. If you don’t want to continue paying this expense, it may make sense to refinance to a conventional mortgage.

Refinancing to get a lower mortgage rate

Refinancing your current mortgage to a lower rate allows you to save money on interest throughout the life of the loan. Plus, if you refinance to a similar term, you’ll most likely make lower monthly payments. Doing so can free up extra cash for other financial objectives, such as paying down high-interest debt or reaching short-term savings goals.

In most cases, you may be able to get a lower interest rate if rates have fallen or your credit situation has improved.

However, if you refinance to a longer term, even with a lower rate, you could pay more overall because you’ll be making more payments.

Refinancing to switch from an ARM to a fixed-rate loan

Switching to a fixed-rate mortgage from an adjustable-rate mortgage offers more stability because you’re paying the same rate throughout the life of your loan. Although an ARM may offer lower introductory rates, they could go up once the initial-rate period is over. However, because ARM rates are tied to a benchmark index, if the index rate falls, your mortgage rate may dip, too, depending on your lender. If ARM rates are lower than what you could get with a fixed-rate mortgage, you’ll want to decide whether the stability is worth it.

Refinancing to cash out on your home equity

Getting a cash-out refinance may be a smart idea, since mortgage interest rates tend to be lower than other forms of debt, such as personal loans or credit cards. You may also be able to borrow a large sum of money, especially if you have a lot of home equity.

However, there are risks to a cash-out refinance. Since your home acts as collateral, you could lose your property if your loan goes into default. Make sure you can afford your new monthly payment before going this route.

Refinancing to pay off your mortgage faster

Refinancing to a shorter term gives you the opportunity to become debt-free sooner. Doing so could be a smart idea if you’re close to paying off your mortgage, your income increases, or you qualify for a much lower interest rate.

Keep in mind refinancing to a shorter term could result in a larger monthly payment, since you’re making payments in a reduced timeframe. Take a good look at your budget to see whether you can comfortably afford it. A refinance calculator can help you predict what your new monthly payments could be.

Mortgage refinancing FAQs

How often can you refinance your home?

While there’s no hard-and-fast rule on how often you can refinance, some loan programs may have specific limitations. These are known as waiting or seasoning periods. For instance, conventional mortgages have “seasoning” requirements for cash-out refinancing, which means you may need to wait a minimum of six months after closing on your current mortgage before taking out another one. Many government-backed loans, such as FHA loans, also have seasoning requirements, although there may be exceptions.

How much does it cost to refinance a house?

You could pay anywhere from 3% to 6% of your new loan amount in closing costs each time you refinance. Common charges include the loan origination fee, appraisal fee, title insurance/search, and (if required in your state) attorney fees.

Some lenders offer no-closing-cost refinances, but this doesn’t mean you won’t pay any closing fees. You’ll either roll the fees into your new loan amount or agree to have your lender pay the closing costs upfront in exchange for a higher interest rate.

Is it worth refinancing for half a percentage point?

Whether it’s worth refinancing will depend on your goals and financial situation. Lowering your interest rate by half a percentage point, for example, might save you thousands of dollars over the life of your loan. Generally, though, you’ll want to stay in your home long enough to realize those savings and recoup your closing costs. The best way to determine whether it’s worth it to refinance is to calculate the break-even point.

Trying to decide whether now is a good time to refinance? Talk to a local Finance of America Mortgage Advisor today to learn more about your options.

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