When to Refinance Your Mortgage

Refinancing can save you money, or cost you money.

To get a lower interest rate

To shorten your mortgage term.

Tapping into home equity to raise funds to meet a financial emergency, finance a major purchase, or consolidate debt.

Because refinancing can cost 3-6% of the principal amount of the loan and, like an original mortgage, requires an appraisal, title search, and application fees, it's essential for the homeowner.

Key findings

Getting a mortgage with a low interest rate is one of the best reasons to refinance.

When interest rates drop, consider refinancing to shorten the term of your mortgage and pay significantly less in interest payments.

Switching to a fixed-rate or adjustable-rate mortgage can depend on prices and how long you plan to stay home.

Drawing on equity or consolidating debt are other reasons to refinance, but be careful; doing so can sometimes worsen debt problems.

Is it worth refinancing?

According to a general rule of thumb, refinancing is advantageous if the new rate is at least 1% lower than the existing rate. More specifically, consider whether the monthly savings are enough to make a positive difference in your life or whether the overall savings over the life of the loan will benefit you significantly.

Refinancing to secure lower interest rates

Refinancing has historically been wise if you can reduce your interest rate to at least 2%. However, many lenders say that a 1% savings is enough incentive to refinance. Using a mortgage calculator is an excellent way to budget for some expenses.

You can reduce your monthly payment and save money by lowering your interest rate, accelerating your home's equity. That same 4.1% loan reduces your cost to $477.

Refinancing to shorten the term of the loan

Homeowners may occasionally refinance an existing loan into a new loan with a significantly shorter term when interest rates decline without considerably altering the monthly payment.

 Payments are from $805 to $817. Getting a mortgage at 3.5% for 15 years will raise your cost to $715 if it is already at 5.5% ($568) for 30 years.

Refinancing to convert to an ARM or fixed-rate mortgage

Although ARMs often start with lower rates than fixed-rate mortgages, periodic adjustments can result in higher rate increases than those available with fixed-rate mortgages. When this happens, switching to a fixed-rate mortgage lowers the interest rate and eliminates the worry of future interest rate hikes.

Conversely, moving from a fixed-rate loan to an ARM, which has lower monthly payments than a fixed-term mortgage, is an excellent financial strategy if interest rates are falling, especially for homeowners. Another justification is that mortgage interest is taxable.

While these arguments may be valid, increasing the years you owe on your mortgage is rarely a wise financial decision, or spending a dollar in interest to get a 30 percent tax deduction. Also, remember that since the Tax Cuts and Jobs Act took effect if you bought your home after December 15, 2017, the size of the loan on which you can deduct interest has been reduced from $1 million to $750,000. Has been done.

Many homeowners refinance to consolidate their debt. At first glance, replacing a high-interest loan with a low-interest mortgage is a good idea. Unfortunately, refinancing does not automatically bring financial prudence. Only take this step if you're confident you can resist the urge to spend once the refinancing gets you out of debt.

Remember that a large percentage of people who have once accumulated high-interest debt on credit cards, cars, and other purchases will pay it off after giving the credit available to do so through mortgage refinancing. I will do it again. This creates an immediate quadruple hit from wasted refinancing fees, lost home equity, additional years of high-interest payments on the new mortgage, and high-interest debt repayments after the credit card expires. Again, the likely result is an endless cycle of debt and eventual bankruptcy.

 If so, carefully research your fundraising options before taking this step. If you do a cash-out refinance, you may be charged a higher interest rate than a new mortgage rate and term refinance, where you don't take any money out.

The bottom line

Refinancing can be wise if it lowers your mortgage payment, shortens your loan term, or helps you build equity more quickly. Before you refinance, take a hard look at your financial situation and ask yourself: How long do I plan to stay in the home? 

Again, remember that refinancing costs between 3% and 6% of the principal amount of the loan. This cost takes years to pay off with savings generated through low interest rates or short tenure. So, if you don't plan to stay in the home for more than a few years, the cost of refinancing can wipe out any potential savings.

It's essential to remember that intelligent homeowners constantly look for ways to lower their debt, increase their equity, save money, and stop making mortgage payments. When you refinance, taking money out of your estate doesn't help you with either of these objectives—your property—more than a few years at home.

These homeowners can lower the interest rate and monthly loan payments but won't worry about higher rates 30 years from now.

If rates continue to fall, periodic rate adjustments on an ARM result in lower rates and smaller monthly mortgage payments that eliminate the need to refinance each time.

Refinancing to leverage equity or consolidate debt

While the justifications above for refinancing are sensible financial moves, mortgage refinancing can lead to a never-ending cycle of debt.

Homeowners frequently use the equity in their homes to pay for significant costs like home renovations or a child's college education. These homeowners may justify refinancing because remodeling increases the home's value or because the interest rate on the home loan is lower than borrowing from another source.