When Does Refinancing Your Mortgage Make Sense?

Refinancing makes sense when the benefits of a new loan outweigh its costs within the time you expect to keep it. That benefit might be a lower rate, a more stable payment, paying off your home sooner or access to equity. The key test is the break-even point: how long it takes for what you gain each month to cover what you paid to refinance, compared with how long you plan to stay in the home.

What refinancing actually is

When you refinance, you replace your current mortgage with a new one. The new loan pays off the old loan, and you start making payments under the new loan's rate and terms. You can refinance with your current lender or a different one.

Refinancing is a full mortgage transaction. It involves an application, a credit check, often an appraisal, a Loan Estimate, a Closing Disclosure and closing costs. It takes time and money, so it is worth doing only when it clearly moves you toward a goal.

Common reasons to refinance

To lower your interest rate

If rates available to you are meaningfully lower than the rate on your current loan, refinancing may reduce your monthly payment and the total interest you pay. Your credit, equity and the loan you choose all affect what rate you may qualify for. Lower monthly payments can free up room in your budget or let you put more toward principal.

To change your loan type

Some homeowners refinance from an adjustable-rate mortgage to a fixed-rate loan for more predictable payments, especially if the adjustable rate is about to reset. Others go the opposite direction if they expect to move before an initial fixed period would end. Refinancing can also be a way to move from one loan program to another, which may change costs such as mortgage insurance.

To pay off your home sooner

If your income has grown, refinancing to a shorter repayment term can help you build equity faster and pay less total interest, though your monthly payment will usually be higher. The reverse also applies: choosing a longer term can lower your payment but may increase total interest.

To take cash out

A cash-out refinance replaces your mortgage with a larger one and gives you the difference in cash. People use it for home improvements, education costs or consolidating debt. Rates on cash-out refinances are generally somewhat higher than on refinances without cash out, and you are borrowing more against your home, so weigh this option carefully. A home equity loan or HELOC may be an alternative if you want to keep your current mortgage in place.

To remove a co-borrower

After a divorce or other life change, refinancing can move the loan into one person's name, subject to that person qualifying on their own.

The break-even idea, explained

Every refinance has upfront costs: lender charges, appraisal, title and other closing costs. The break-even point is the time it takes for your monthly benefit to add up to those costs.

Conceptually, it works like this:

1. Add up the total cost of the refinance from your Loan Estimate.
2. Figure out how much you would gain each month, usually the difference between your old and new principal and interest payment.
3. Divide the total cost by the monthly gain. The result is roughly how many months it takes to recover what you spent.

Then compare that timeline with how long you expect to keep the loan. If you plan to stay well past the break-even point, the refinance may pay off. If you might sell or refinance again before you get there, you may spend more than you save.

Where the simple break-even math falls short

This method is a useful starting point, but it does not tell the whole story:

• Restarting the clock. If you have been paying your loan for a while and refinance into a new full-length term, your monthly payment may drop, but you could pay more total interest over the life of the loan. Look at total cost, not just the monthly payment.
• Shortening the term. If you refinance to a shorter term, your payment may go up even as total interest goes down, so a monthly-savings calculation does not apply.
• Cash-out refinances. When you take cash out, you are borrowing more, so comparing old and new payments does not measure the value of the refinance.
• Costs rolled into the loan. Some lenders offer to add closing costs to your loan balance or cover them in exchange for a higher rate. That reduces cash at closing but usually raises what you pay over time.

When refinancing may not make sense

• You expect to move before reaching the break-even point.
• The new loan would stretch your repayment far past your current payoff timeline and increase total interest more than you are comfortable with.
• Your credit or equity has changed in a way that would limit the terms available to you.
• Your current loan has terms that a new loan is unlikely to match.
• You would use a cash-out refinance for spending that does not improve your long-term financial position.

How to evaluate a refinance offer

Request Loan Estimates from more than one lender for the same loan type and term, on or close to the same day. Because the Loan Estimate is a standard form, you can compare offers line by line. Look at the interest rate, the loan costs a lender charges, the total closing costs and the estimated cash to close.

Ask yourself a few questions as you compare:

• Will I stay in the home long enough to recover the costs?
• Will this refinance extend my repayment timeline and increase total interest?
• Do I understand every fee, and why it is charged?
• Does the lender explain the terms clearly and answer my questions?

Rate locks and timing

Once you choose a lender, ask about a rate lock. A lock holds a quoted rate for a set period while your loan is processed, as long as the details of your application do not change. Ask how long the lock lasts, whether there is a cost to extend it and what happens if closing is delayed. Delays often come from missing paperwork, so respond quickly to document requests.

Your credit also matters while the refinance is in progress. Avoid opening new credit accounts or taking on new debt until you close, since changes to your credit or income can affect your approval and terms.

What you will need

Expect the lender to check your credit and review your income, assets, debts and home value. Gather recent pay stubs or other proof of income, tax returns, bank statements, your current mortgage statement and homeowners insurance information. Programs and approval vary by borrower, property and investor, and every loan is subject to credit approval.

If you are not sure refinancing is right for you, or if you are behind on payments, a HUD-approved housing counselor can walk through your options with you before you apply.

Frequently asked questions

Next steps

• Mortgage Refinance
• Cash-Out Refinance

Sources

• Freddie Mac: Planning to refinance
• Freddie Mac: Understanding your options for refinancing
• Freddie Mac: 6 questions to ask before you refinance
• CFPB: Your home loan toolkit