Your home is one of the most expensive things you’ll buy in your life. They’re so expensive that most people need to use a mortgage to borrow money to buy their home.
Some people call mortgages “good debt” because they help you buy an asset. Real estate is valuable, and owning a home can help you avoid the uncertainty caused by changing rent prices. Home values can also rise over time, making homeownership one strategy for increasing wealth.
One option for turning that good debt into even better debt is through refinancing. Given the right conditions, refinancing your mortgage lets you adjust the terms of your loan, reducing the interest rate or monthly payment and helping you save money.
What is Refinancing?
Refinancing your home loan means replacing your existing loan with a new one. In effect, you get a new mortgage for your home and use that money to pay off your current mortgage.
Refinancing gives you the chance to adjust things about your loan, such as the interest rate, the loan term, and the monthly payment. You can also use a cash-out refinance to turn your home equity into cash that you can use for other purposes, at the cost of increasing your mortgage debt.
Just like when you applied for your mortgage, refinancing your home means going through the lending process again. You have to find a lender to work with, apply for a mortgage loan, and let the lender check your credit and financial situation. It can feel like a hassle, but in many cases, refinancing your mortgage can be well worth the effort and cost.
The Truth About Mortgage Refinancing
Before you refinance your mortgage, there are a few key factors that you have to consider, including how much refinancing will cost, whether you can secure a lower interest rate, and what your break-even point will be.
Refinancing takes effort, and you have to pay closing costs and other fees, so it’s important that you only go through a mortgage refinance if it benefits you, such as by helping you lower your monthly payments or giving you cash you can use to pay off other debts.
Pros and cons of refinancing your mortgage
Here is a list of the benefits and the drawbacks to consider.
- If you refinance with a lower rate, you could pay less interest every month and over the lifetime of your loan.
- If you have to pay mortgage insurance and you refinance into a loan that doesn’t have it, you could save money every month and over the lifetime of your loan.
- Shortening your loan’s term might help you save money by paying off your loan sooner.
- If you lengthen your loan’s term, your monthly payment might be lower and more affordable for you.
- In cases where you refinance from an adjustable or hybrid rate into a fixed rate, you won’t have to worry about having a higher rate or payment in the future.
- If you have enough equity in your home, you might be able to get cashback when you refinance. You can use the cash to pay off credit cards or other debt, make repairs or improvements to your home, or for other needs or wants.
- You might be able to refinance with no out-of-pocket costs by adding your costs to your loan or letting your lender pay your costs in exchange for a slightly higher interest rate.
- If you refinance with a higher interest rate, you might pay more interest every month and over the lifetime of your loan.
- If you refinance to a shorter-term, your rate might be lower, but your monthly payments could be higher.
- Refinancing to a longer-term may lower your payment, but you might pay more interest over the lifetime of your loan.
- You’ll have to pay closing costs, which could be thousands of dollars out of pocket.
- If you plan to sell your home within the next few years, you might not recover your closing costs.
- You’ll have to spend time researching lenders, choosing a loan, gathering your financials, and signing your closing documents.
What are the Benefits of Mortgage Refinancing?
Refinancing your mortgage offers a host of potential benefits. It gives you the opportunity to trade in your loan for a new one so you can renegotiate some of its terms.
One of the most popular reasons to refinance a home loan is interest rates. The interest rate market changes regularly, and lenders like banks and credit unions set mortgage rates based on major, benchmark interest rates. When those benchmark rates fall, mortgage rates tend to fall. If those benchmark rates rise, mortgage rates tend to rise.
If you got your first mortgage when rates were high, or you had a bad credit score, refinancing may let you lower the interest rate on your home loan. This can save you money in the long run by reducing the lifetime interest costs of the loan. It also reduces your monthly payment.
Refinancing can also let you turn an adjustable-rate mortgage into a fixed-rate mortgage. Adjustable-rate loans give you far less predictability when it comes to rates and your monthly payment. Changing to a fixed-rate mortgage means more predictability and less worry about affording your mortgage payments if rates go up.
Another way to secure a lower monthly payment on a new loan is to refinance once you’ve built enough equity to avoid private mortgage insurance (PMI). With many lenders, you need to pay PMI each month if you get a loan with less than 20% equity. As your home value rises and you pay down your balance, you may build enough equity to avoid PMI by refinancing, which will lower your monthly payments.
Why Is Refinancing a Bad Idea?
Refinancing isn’t always a great idea. There are situations where it can be a bad thing to do.
When you refinance, lenders will take a look at your credit score and financial situation. If you’ve wound up in credit card debt, damaged your credit score, or have a job that pays less than you did when you got your first loan, you may get worse terms when you try to refinance.
Even if you still have great credit, if market interest rates have increased, you’ll likely be looking at a new loan with a higher interest rate instead of a lower rate.
Refinancing also means paying closing costs and other fees, just like you did when you got your first loan. If you can’t afford to pay these costs out of pocket, you may be able to roll them into the new loan, but they still add to the overall cost of refinancing.
Homeowners who want to save money by refinancing need to calculate their break-even point for their new home mortgage. The break-even point is the amount of time they have to live in the home to start saving money overall after accounting for the lower mortgage payment and the closing costs they had to pay.
When Is It Worth to Refinance at a Lower Interest Rate?
When refinancing at a lower interest rate is a good idea depends largely on how long you plan to live in your home, the cost of refinancing, and how much lower the mortgage rate will be on your new home loan.
Before you refinance, you need to calculate the break-even point of the new mortgage. Refinancing at a lower interest rate means a lower mortgage payment each month, but you have to pay closing costs and other upfront costs to secure that lower monthly payment.
If it costs you $10,000 to refinance and you only save $50 per month, it will take a long time for the monthly savings to pay off.
If refinancing to a lower mortgage rate doesn’t save you money, you need to have another reason to refinance, like cashing out equity to pay off other debts.
In general, the lower the interest rate on a new mortgage compared to your existing mortgage, and the longer you plan to stay in your home, the more sense it makes to refinance. If you can save a few hundred dollars a month, that can make a massive difference over the course of a thirty-year mortgage.
Should You Refinance at Higher Interest Rates?
Refinancing at a higher interest rate is generally a bad idea, but there are a few situations where it makes sense.
When you refinance your loan to a higher interest rate, if you keep the loan’s term the same, it will increase your monthly payments because more interest will accrue on the loan. It also increases the total interest cost of the mortgage.
An exception to this is when refinancing lets you get out of paying PMI. If you refinance your loan and have to pay an extra $50 in interest each month but get out of paying $100 in PMI, refinancing with a higher rate will save you money in the long run.
Refinancing with a higher interest rate also makes sense if you want to transition from an adjustable-rate mortgage to a fixed-rate loan. With ARMs, your monthly payment can be unpredictable as the loan’s interest rate can change. A fixed-rate loan, even one with a higher interest rate, can be appealing because you know you don’t have to worry about your payment increasing and becoming unaffordable.
Another way that refinancing to a loan with a higher interest rate can save money month-to-month is by extending your loan’s term. If you have fifteen years left on your mortgage and refinance it to a thirty-year loan without taking any equity out of your home, you’ll have a lower monthly payment. Keep in mind that this will increase the total interest cost of your loan.
Do You Have to Pay Closing Costs When You Refinance?
Refinancing your mortgage isn’t free. Just like when you got your first loan, you have to pay closing costs and other fees.
For example, homeowners typically have to pay for things like appraisal of their home, origination fees, and loan processing fees. It’s important to shop around and look at offers from multiple lenders as refinancing costs will differ. You also want to make sure you like the lender you work. After all, you will be dealing with them for many years to come, making the choice of a lender an even more important decision.
You can expect to pay between 1% and 5% of your loan amount in fees, with typical costs landing between 2% and 3%.
“Always ask a lender for a detailed explanation of all fees. Also, ask if the new loan will increase your loan balance or if you could get a lower rate if you paid the fees out of pocket,” says Jennifer Beeston, vice president of mortgage lending at Guaranteed Rate in Santa Rosa, Calif.
Is Refinancing Your Mortgage Worth It?
The bottom line is that there are many cases where refinancing is a good idea and just as many where refinancing isn’t worth it.
Can refinancing your loan save you money in the long run based on how long you plan to live in the home and the fees and monthly payments attached to the new mortgage? If so, a refinance is probably a good idea.
Can refinancing your loan, even if it increases the loan’s total cost, give you something you want, like a fixed interest rate instead of an adjustable one or cash that you can use to pay off other debt? If so, refinancing might be a good thing to do.
Will refinancing make your loan more expensive in the long run? Unless you have another good reason to refinance, you probably shouldn’t do it. As with any financial situation, take the time to think about your goals and whether refinancing will help you reach those goals. It’s always a good idea to do research and consult with a financial advisor.
If you think that refinancing is right for you, don’t forget to shop around for the best deal. Start by checking out our reviews of the top mortgage refinance lenders.
Do you need to compare mortgage refinance loans? You can also use the SuperMoney comparison tool to compare mortgage refinance lenders side-by-side and narrow down your top three options. Then, get in touch with those lenders to discover how much money, if any, you could save by refinancing your mortgage with them.
Marcie Geffner is an award-winning freelance reporter, editor, writer and book critic. Her work has been featured online and in print by The Washington Post, Los Angeles Times, Chicago Sun-Times, Urban Land, Business Start-Ups and Fox Business Network Online, among many other newspapers, magazines, and websites. With a bachelor’s degree in English from UCLA and MBA from Pepperdine University in Malibu, Geffner has impressive credentials in both story-telling and business management. A second-generation native of Los Angeles, Geffner now lives in Ventura, California, a surf city northwest of her hometown.