When Should You Refinance Your Mortgage?

We break down the right — and wrong — reasons you should consider refinancing your home loan

August 1, 2021 2:19AM EDT

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If you’re wondering whether it’s time to refinance your mortgage, you first need to know how much you stand to save and how much refinancing will cost you.

Ideally, refinancing will save you money in both the short term and the long term by reducing your monthly payment and lowering your interest rate. But you’ll need to make sure the savings are large enough that you won’t lose money after paying the closing costs to refinance your mortgage.

What Is a Mortgage Refinance?

A mortgage refinance is the replacement of your existing mortgage with a new mortgage that has different terms. Usually, one of those terms is a lower interest rate. Sometimes, it’s a different number of years until payoff. Less commonly, it’s a fixed rate instead of an adjustable rate, or vice versa.

It can also be a different type of loan, like a conventional mortgage instead of an Federal Housing Administration (FHA) mortgage. In any case, the goal is that your new mortgage is more beneficial for you, like lower monthly payments, than your existing mortgage.

When Is It a Good Time to Refinance My Mortgage?

Homeowners refinanced $2.6 trillion in mortgage debt last year thanks to record-low mortgage rates, according to Freddie Mac, a quasi-government agency that helps support the mortgage market. Rates remain exceptionally low, so it’s worth running the numbers and seeing how much you could save by refinancing now. Here are some signs the time might be right.

You can lower your rate by at least 0.5%. There’s no hard-and-fast rule that determines what interest rate drop makes refinancing worthwhile. You have to calculate how much you’d save based on each lender’s offer. But if the current rates are lower than your existing rate, it’s a good time to do the math and seek options. The typical homeowner who refinanced in 2020 lowered their rate by 1.2 percentage points, according to Freddie Mac. Borrowers with very good to excellent credit to get the best rates.
You can pay off your mortgage faster. Refinancing into a shorter mortgage term can potentially save you more by combining a lower interest rate with fewer years of payments.

For example, if you’ve borrowed $300,000 and your rate on a 30-year mortgage is 3.5%, your monthly payment is $1,350 and you’ll pay $185,000 in interest over 30 years.

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If you refinance that amount into a 15-year loan at 2.1%, your new monthly payment will be $1,900, and you’ll pay $49,000 in interest over the next 15 years (plus the roughly $10,000 in interest you paid during the first year of your 30-year mortgage). You’ll save $126,000 in the long run, minus closing costs of around $3,000.

The question is whether you can comfortably afford the higher monthly payment on the shorter mortgage: an extra $550 a month for 180 months, in this example.

You want a different kind of mortgage. If you have an adjustable-rate mortgage but you’d prefer to lock in a fixed rate, that’s a valid reason to refinance. If you originally took out an FHA loan because your credit wasn’t great, but now your score is much higher, you might want to refinance into a conventional loan to stop paying FHA mortgage insurance premiums.
You want to cash out a chunk of equity. As of June, home values were up 15% compared to the previous year, according to Zillow. If you’ve been looking for a source of cash for home repairs, remodeling, or paying off high-interest debt, a cash-out refinance could make sense if you’ll be able to lower your mortgage rate.

When Is Refinancing a Bad Idea?

It’s tempting to want to refinance when you see how low the current market rates are, and how many other people are doing it. However, after considering your own circumstances, you might find that refinancing isn’t a good choice for you if one of these situations applies.

You’ll extend your loan term substantially. Suppose you’re five years into a 30-year mortgage. If you refinance into another 30-year loan, you’re putting yourself in a situation where you’re paying a mortgage for 35 years instead. Since you mostly pay interest during the first years of a 30-year loan, this type of refinancing can be costly in the long run even if it lowers your monthly payment in the short run.
When your break-even period is too long. If refinancing into a shorter term is not an option, you’ll want to calculate your break-even point. Divide your closing costs by your monthly savings to see how long it will take you to come out ahead by refinancing. For example, if you’d pay $3,000 to refinance into a new 30-year mortgage that saves you $200 a month, it would take you 15 months to break even. If you planned to sell your home in a year, you would lose money by refinancing.

You don’t have a good plan for how you’ll use cash-out refi money. Just because you can do a cash-out refinance doesn’t mean you should. If your goal is to one day be mortgage free, and if your cash-out refinance will not substantially improve your finances or your quality of life, you may just want to skip it.
You’re out of work. Most of the time, you will not be able to refinance if you’re unemployed. If you have an FHA or VA loan, you may still qualify for a streamline refinance. If you’re having trouble making payments on your conventional loan, you may qualify for a loan modification. However, without a steady source of income, you probably won’t be able to refinance your conventional loan.

How Do I Refinance My Mortgage?

Refinancing will probably feel easy since it’s not your first time applying for a mortgage. You already know how the process will unfold.

What To Expect During Refinancing

After submitting your application, you’ll need to give the lender documents such as recent bank statements, tax returns, W-2s and pay stubs that prove you’ll be able to repay the new loan. Then, you’ll wait.

In June, the average time to close on a refinance was 48 days according to ICE Mortgage Technology.

Interest Rates

At some point in the refinancing process, you’ll need to lock your interest rate. Your lender should be able to tell you how long you can expect your loan to close based on the company’s current turn times.

You want to make sure your rate lock will last long enough to get you through closing. You’ll probably want to lock your rate early in the application process to eliminate the risk of a rate spike that would affect your decision to refinance.

Additional Fees

Refinancing usually costs less than 1.3% of the loan amount when including taxes, according to ClosingCorp, a real estate closing cost intelligence company. The average closing costs on a refinance for a single-family home was $3,398 with taxes in 2020.

These are the fees you can expect to pay when you refinance:

Application fee
Loan origination fee
Credit report fee
Points to buy down your rate (optional)
Home appraisal fee
Pest inspection fee
Real estate transfer taxes (if applicable in your jurisdiction)
Title search and lender’s title insurance fee
Land survey (sometimes)
Escrow/closing service fee
Notary fee

If the numbers will work out in your favor, refinancing can be a great way to save money. While the process can have its administrative headaches, it tends to be worth the wait (and work) in the end.