Should You Refinance Your Mortgage? How to Decide

Refinancing — paying off your existing mortgage and getting a new one — can be good for your finances, if you get a better interest rate and/or lower monthly payments.

However, there are fees for refinancing, so it’s not always the ideal choice. Also, refinancing can lengthen the term of your loan, which could cost you more over time.

Here’s a look at the benefits and costs of refinancing to help you determine whether it’s a good time for you to re-do your mortgage loan.

Interest rates drive decision

One of the main advantages of refinancing is to get a reduced interest rate, which can save you a substantial amount of money. A reduced interest rate can mean a lower monthly mortgage payment and thousands of dollars saved in interest over the life of the loan.

For instance, if you currently have a $250,000 mortgage balance and you’re paying a 6% fixed annual percentage rate (APR) on a 30-year loan, your mortgage payment will be $1,888, according to Zillow. If you reduce that to 4% fixed on the same loan, your mortgage payment will change to $1,583, which is a cost savings of $3,660 per year. That amounts to almost two less mortgage payments a year. Just be aware this does not factor in the upfront fees of refinancing.

The cost of refinancing your home

There are costs associated with refinancing your home, which are about 3% of your loan principle, the Home Buying Institute estimates. For example, fees and other associated refinancing costs on a $200,000 mortgage would be an estimated $6,000. Compare these costs to the amount of money you’ll save in interest.

Closing costs can be paid up front, or rolled into your refinanced monthly mortgage payment. If you choose to finance your closing costs, the monthly loan payments will be higher than if you had paid the closing costs out of pocket. Experian’s Freecreditscore.com offers a closing costs calculator that lets you figure out the impact of paying these fees upfront or rolling them into the loan.

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If you’re planning on moving in the next three to five years, it may not make sense to refinance and pay the upfront fees, as it will take you more years in interest savings to recoup the costs.

Before negotiating a new loan, familiarize yourself with the various expenses:

  • Mortgage application fee:
    This covers the cost of pulling your credit report and processing your loan request. The cost is usually $100 to $350.
  • Origination fees:
    These loan-processing fees are percentage points of the overall amount of the loan. If the lender charges you a one-point origination fee on a $150,000 home, that fee would be $1,500, according to the Home Buying Institute.
  • Attorney fees:
    Many mortgage lenders have a lawyer review the various documents. This ranges from $100 to $300.
  • Title search and insurance:
    Before refinancing, the lender you choose will look at public records to make sure you own the property you’re refinancing. This usually costs about $400.
  • Appraisal fee:
    Refinancing generally requires that you have your home appraised. This helps the lender determine whether you’re eligible to refinance and ensures your home’s worth. Home appraisal fees range from $150 to $450. The outcome of the appraisal can determine whether you should refinance; most conventional lenders look for a loan-to-value ratio at or below 80% to approve refinancing.

Look into shortening the length of your loan

If you wish to accelerate the pace at which you pay off your mortgage, refinancing can allow you to do that. You could, for instance, reduce a 30-year loan to a 15-year one, which would greatly reduce the amount of interest you pay over the life of the loan. This could also allow you to build equity in your home more quickly.

Shortening the length of your loan usually raises the amount of money you pay each month for your mortgage payment, which may mean a tighter budget. Combine the shortened length of the loan with a reduced interest rate, though, and you may not have a big jump in the monthly payment amount.

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Decide whether to change your loan type

If you currently have an adjustable rate mortgage (ARM), which tends to have a lower interest rate initially that rises over time, refinancing gives you the opportunity to change to a fixed rate mortgage that stays the same over the length of the loan. On the other hand, if you have a fixed rate and would like to take advantage of low interest rates, you might find it beneficial financially to switch to an ARM. These loans tend to be a good idea if you plan on staying in your home for only a few years.

Best mortgage lenders for refinancing

While you can return to your original mortgage lender to refinance, you should do some research to see whether you could get better interest rates and loan terms if you try an online mortgage lender.

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Still unsure about refinancing?

When used wisely, refinancing can help you get ahead financially by reducing your mortgage interest rate and lowering your monthly mortgage payment or shortening the length of your loan so that you more quickly build equity.

For information on the best mortgage lenders for your financial situation, visit SuperMoney’s best home loans reviews & comparisons page.