A mortgage can last for decades, and a homeowner’s financial situation can change significantly during that time. When interest rates, income, credit or financial goals change, some homeowners consider refinancing their existing mortgage.
Refinancing means replacing an existing mortgage with a new loan. Depending on the circumstances, the new loan may offer a different interest rate, loan term or monthly payment.
However, refinancing is not automatically a good financial decision. Closing costs and other expenses can reduce the benefit of a lower interest rate.
Understanding the numbers before refinancing can help homeowners decide whether the move makes sense for their situation.
What Does Mortgage Refinancing Mean?
When you refinance, you take out a new mortgage to pay off your existing mortgage.
The new loan becomes your current mortgage, with its own interest rate, repayment period and terms.
For example, a homeowner who currently has a 30-year mortgage may refinance into another 30-year mortgage, a 15-year mortgage or another available term.
The best option depends on the homeowner’s goals and financial situation.
Why Do Homeowners Refinance?
There are several reasons someone might consider refinancing.
One of the most common is trying to obtain a lower interest rate.
A lower rate can potentially reduce the monthly principal-and-interest payment or reduce the total interest paid over the life of the loan.
Other homeowners refinance because they want to change the loan term, move from one type of mortgage to another or access home equity.
The reason for refinancing matters because a loan that makes sense for one homeowner may not make sense for another.
A Lower Interest Rate Isn’t the Only Factor
It can be tempting to refinance as soon as a lower mortgage rate becomes available.
But the interest rate is only one part of the calculation.
Refinancing generally involves costs such as lender fees, appraisal costs, title-related expenses and other closing costs.
The Consumer Financial Protection Bureau recommends comparing the costs and benefits of refinancing rather than looking only at the new interest rate.
A homeowner should consider how much the refinance costs and how long it will take to recover those costs through savings.
Understanding the Break-Even Point
The break-even point is one way homeowners can evaluate a refinance.
Suppose refinancing costs $6,000 and the new mortgage saves $300 per month.
Dividing $6,000 by $300 gives 20 months.
In this simplified example, the homeowner would need to keep the new mortgage for approximately 20 months before the monthly savings offset the upfront refinancing costs.
The actual calculation can be more complicated because taxes, insurance, loan terms and other expenses may change.
Still, the basic idea is useful.
If you expect to sell the home before reaching the break-even point, refinancing may not provide the expected financial benefit.
Refinancing Into a Shorter Loan Term
Some homeowners refinance from a 30-year mortgage into a 15-year mortgage.
A shorter loan term can allow homeowners to pay off the mortgage faster and potentially pay less interest over the life of the loan.
However, the monthly payment may increase significantly.
That means homeowners need to make sure the higher payment fits comfortably within their budget.
A shorter term may be attractive for someone with a stable income who wants to become mortgage-free sooner.
Refinancing Into a Longer Term
The opposite strategy is also possible.
A homeowner may refinance into a longer repayment period to reduce the monthly payment.
While this can improve monthly cash flow, extending the loan can increase the total interest paid over time.
For this reason, a lower monthly payment does not necessarily mean a cheaper mortgage overall.
Homeowners should compare the total cost of the new loan rather than focusing only on the monthly payment.
What Is a Cash-Out Refinance?
A cash-out refinance allows a homeowner to refinance for more than the remaining balance on the existing mortgage and receive the difference in cash, subject to the loan’s requirements and available home equity.
For example, if a homeowner owes $200,000 and qualifies for a new $250,000 mortgage, part of the new loan can be used to pay off the old mortgage and the remaining amount may be received as cash.
The money could potentially be used for home improvements, debt repayment or other expenses.
However, cash-out refinancing also increases the mortgage balance and uses the home as collateral.
That makes it important to carefully consider whether the additional debt is appropriate.
Your Credit Can Matter
Mortgage lenders generally evaluate a borrower’s financial situation when considering a refinance.
Credit history, income, debt and other financial factors can influence the terms available to a borrower.
Before applying, it can be useful to review your credit reports and address errors if you find them.
Borrowers should also compare offers from multiple lenders instead of assuming their current lender will automatically provide the best terms.
Compare More Than One Lender
Mortgage rates and fees can vary between lenders.
When refinancing, homeowners should request loan estimates and compare the complete cost of each offer.
Important factors can include:
- Interest rate
- Annual percentage rate
- Closing costs
- Origination charges
- Loan term
- Monthly payment
- Mortgage insurance
- Prepayment terms
- Total interest
The Consumer Financial Protection Bureau provides resources for comparing mortgage offers and understanding loan costs.
Watch Out for “No-Closing-Cost” Refinancing
Homeowners may see refinancing offers advertised as having no closing costs.
That does not necessarily mean the refinance is free.
In some cases, the lender may charge a higher interest rate or add costs to the loan balance.
Before accepting such an offer, ask how the closing costs are being covered.
Compare the total cost over the period you expect to keep the mortgage.
Consider How Long You Plan to Stay
Your expected time in the home is an important part of the refinancing decision.
If you plan to move within a year or two, paying thousands of dollars in refinancing costs may not make sense.
If you expect to remain in the home for many years, a lower rate could potentially provide greater long-term savings.
Of course, future plans can change, so this calculation is never completely certain.
Don’t Ignore Your Other Financial Goals
Refinancing should be considered as part of your broader financial situation.
For example, if you have high-interest credit card debt, a large emergency fund gap or other major financial priorities, putting money toward refinancing costs may not be your best move.
On the other hand, refinancing may fit well into your plan if you have stable finances and can significantly reduce borrowing costs.
Ask for the Numbers in Writing
Before agreeing to a refinance, ask the lender for detailed information about the proposed loan.
You should understand the interest rate, monthly payment, closing costs and other important terms.
Do not hesitate to ask questions if something is unclear.
A mortgage is a significant financial commitment, and homeowners should understand the terms before signing.
When Refinancing May Make Sense
Refinancing may be worth considering when:
- The new interest rate is meaningfully lower.
- You expect to stay in the home long enough to recover refinancing costs.
- Your financial situation has improved.
- You want to change the loan term.
- You want to replace an existing loan with terms that better fit your goals.
These factors do not guarantee that refinancing is beneficial, but they can be good reasons to compare available options.
When Refinancing May Not Make Sense
Refinancing may be less attractive when:
- Closing costs are too high.
- You plan to sell the property soon.
- The monthly savings are very small.
- The new loan significantly extends the repayment period.
- Your financial situation makes the new loan difficult to qualify for or afford.
Every homeowner’s situation is different.