When to refinance your mortgage. Like many homeowners, your monthly mortgage payment likely makes up the largest expense on your list of financial responsibilities. Although rates are rising, you might still be able to make your payment smaller if you consider an important question: Should I refinance my mortgage?
Should I refinance my mortgage?
With interest rates on the rise, now is likely not the ideal time to refinance for many borrowers.
However, 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 Take into account these three factors, recommends Bill Packer, executive vice president and chief operating officer of mortgage lender American Financial Resources.
The after-tax monthly savings (new payment compared to old payment after any tax-favored treatment); 2.) the amount of time that I intend to be in the home; and 3.) the cost to obtain the new mortgage. Once you know these three things, you can then calculate your return and see if it is positive
— Bill Packerexecutive vice president and chief operating officer of mortgage lender American Financial Resources
When it’s a good idea to refinance your mortgage
Generally, if refinancing will save you money, help you build equity and pay off your mortgage faster, it’s a good decision. It’s best to do if you can lower your interest rate by one-half to three-quarters of a percentage point, and plan to stay in your home long enough to recoup the closing costs.
Reasons to refinance
- 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.
- Consolidate high-interest debt: You can use a cash-out refinance to tap your home’s equity and pay down or pay off higher-interest debt such as a credit card balance.
- Eliminate private mortgage insurance: If your home’s value has increased, you could refinance to get out of paying private mortgage insurance (PMI).
So, when is it a bad idea to refinance? It might not be smart to refinance if you plan to move in the near future, which gives you little time to recoup the cost.
The question of when to refinance is not just about interest rates or your timeline, either, however; it’s about your credit being good enough to qualify for the right refinance loan. The best rates and terms go to those with the best credit, so check your credit report to have a solid understanding of your risk profile. If you’re carrying a high credit card balance or you’ve missed a payment recently, you might look like a riskier borrower.
How much can I save by refinancing?
The amount you can save by refinancing depends on factors including your closing costs, which typically total 2 percent to 5 percent of the principal amount of the loan. If you borrow $250,000 and closing costs are 4 percent, for example, you would owe $10,000 at closing.
Rather than require all that money upfront, many lenders let you 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.
You won’t begin to reap the benefits of a refinance until you reach the break-even point, where the amount that you save exceeds the amount you spent on upfront costs.
You won’t begin to reap the benefits of a refinance until you reach the break-even point, where the amount that you save exceeds the amount you spent on upfront 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 an additional five years after that point, the savings really start to add up — $9,000 total.
You can use Bankrate’s 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 of a mortgage refinance
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 approximately $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, less closing costs, compared with your original loan.
How long does it take to refinance a mortgage?
Refinancing a mortgage doesn’t happen overnight. The same work involved in your first mortgage — verifying your income and reviewing your credit and debt, appraising the property, underwriting and closing — applies here, too. The average refinance took 48 days to close, or about a month-and-a-half, as of April 2022, according to ICE Mortgage Technology.
Some lenders complete closings faster thanks to automated online processes. When shopping around for refinance options, ask each lender about their average closing times and the estimated closing costs you’d need to pay.
Is refinancing worth it?
If it frees up money in your monthly budget or reduces the overall cost of the loan, refinancing is well worth the work and money.
There’s no one correct path to do it, however — there are a variety of ways to refinance your mortgage. You might want to switch from an adjustable-rate mortgage to a fixed-rate loan that has a steady monthly payment, or you might want to shorten the term of your loan from a 30-year to a 15-year and save yourself a bundle in interest charges. You could also simply move from one 30-year mortgage to another 30-year mortgage with a lower rate.
Additionally, refinancing presents a way to get rid of PMI after you have accumulated 20 percent equity in your home.
Many homeowners opt for a straight rate-and-term refinance that lowers their interest rate and gives them a comfortable repayment term. Some want a lower monthly payment to free up money for other expenses, such as college tuition or an auto loan.
While rate-and-term options should help you save money, a cash-out refinance can help you borrow more of it. With this approach, you’re able to take additional cash out with the new loan that can go toward other financial moves, such as paying off credit card debt (since that has a higher APR, you’ll be reducing the cost of the debt) or for a big home remodeling project.
There are pros and cons for cash-out refinances, so you’ll need to think carefully about what you plan to do with the money to figure out whether you should increase the size of your home loan. By taking on more debt, you’re ultimately making paying off your mortgage more challenging, and likely more expensive.
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