It’s a dilemma that many homeowners find themselves in: to refinance or not to refinance. Replacing your existing home mortgage with one that has better terms has many potential benefits like lower monthly payments and smaller interest payments. However, it comes with some upfront expenses, and, if you aren’t careful, can actually cost you more.
To help you learn if refinancing is right for you, we’ve broken down the best time to refinance your home and questions you should ask yourself beforehand.
Questions to Ask Before Refinancing
Start by asking yourself some basic questions:
- How long do I plan to stay in my home?
- What is my current interest rate and what could my new interest rate be?
- What is my current monthly payment and what will my new monthly payment be?
- Will I need to use additional cash, including the refinanced loan, for things like paying off credit cards?
- What are the closing costs associated with a refinance?
These important questions will help you determine if you’ll benefit from refinancing. For example, if you don’t think you’ll be staying in your home for very long it might not make sense to refinance. Refinancing often pays off over time, meaning it can take several years to recoup the money you spend on closing costs.
When Should You Refinance Your Home?
Here are five situations where it makes good financial sense to refinance your house.
1. When you can get the best mortgage refinance rates
One of the most popular reasons why people refinance their home is if they have an opportunity to get a better interest rate. At a lower interest rate, a refinanced home mortgage may significantly decrease the amount of money you pay in interest over time.
Mortgage rates fluctuate due to economic factors, including housing marketing conditions and decisions made by the Fed. You may find yourself in a situation where banks are offering much lower interest rates than what you are currently locked in at. In this situation, replacing your existing mortgage with a new one at a lower rate could be a smart money move.
Has your credit score improved?”
Similarly, you may qualify for a better rate if your credit score has improved since you bought your house. If you’ve been working to better your credit history and raise your score, your mortgage refinance rates can save you.
In general, a good rule of thumb is at least a 1% rate improvement is worth the cost to refinance a mortgage, but be sure to calculate the savings for yourself.
2. When you’ve acquired 20% equity in your home
Some mortgages, like FHA loans, require you to pay a mortgage insurance premium (MIP) for the life of the loan. Conventional mortgages, on the other hand, only require mortgage insurance until you’ve acquired 20% equity in the house.
If you have an FHA loan or another product that requires you to pay a monthly insurance premium, refinancing to a conventional mortgage after you have 20% equity can save you that extra cost.
3. When you’re looking to access home equity without a home equity loan or a home equity line of credit (HELOC)
A cash-out refinance may be a good option for you if you need funds for things like:
- College expenses
- Medical expenses
- Paying off high-interest debt
- Home improvements
With a cash-out refinance, the balance owed on your current mortgage is greater than your old one. The difference is money that goes in your pocket. There are rules in place for who can get a cash-out refinance and for how much, so be sure to do your homework ahead of time.
It’s also important to weigh all of your options when it comes to a cash-out refinance. There are other ways to tap into your home’s equity— like a home equity loan or line of credit— without having to refinance.
4. When refinancing to get a shorter loan term
Interest rate isn’t the only thing that can change when you refinance— so can the length of the loan term. If you have a 30-year loan, you can refinance into a 15-year loan, significantly reducing the amount of money that you spend in interest over the lifetime of the mortgage.
Keep in mind that unless you can also receive a significantly reduced interest rate, reducing the loan term increases your monthly payment. But if you’re in a position to put more towards your mortgage each month, you can pay off your mortgage years earlier.
5. When refinancing to a fixed-rate or an adjustable-rate mortgage
After a few years into your loan, you may evaluate your mortgage situation and discover that the type of loan you took out isn’t the best option anymore.
Perhaps you have an adjustable-rate mortgage (ARM) whose periodic rate increases have made your interest rate higher than those of a fixed-rate. You could refinance your ARM with a fixed-rate mortgage that won’t experience rate hikes.
Or, on the other hand, maybe rates are falling, but you have a fixed rate. You may decide to refinance to an ARM so you can take advantage of the decreasing rates. Just be careful with this scenario, because rates could always go back up, leaving you with higher payments than you started with.
How to Calculate if a Refinance Is Worth It
Whenever you take out a new loan to refinance, there will be upfront and closing costs. These fees may include:
- Loan application fee
- Home appraisal
- Title search and insurance fee
- Origination fee
- Credit report fee
- Termite and pest inspections
These seemingly small fees can really add up, too! Always do the math before refinancing to find your breakeven point. The breakeven point is when the savings you get with your new mortgage surpasses the closing costs that you paid. You can do this by hand or use a mortgage refinance calculator online.
Is a Home Refinance Right for You?
It’s always important to understand the situations where it’s best to refinance before you head down to the bank to take out a new mortgage. People who find themselves in one of the above five situations often reap the benefits of refinancing, including smaller monthly payments and less interest paid over time. Be sure to put pencil to paper and do the math, though. Forgetting to do so could end up costing you in the long run.