Should you refinance your mortgage? The general rule of thumb is if you can reduce your current interest rate by 1% or more, it is worth it to do a mortgage refinance. And many people are happy to follow this rule as long as it lowers their monthly payment or lets them take out some cash, without digging deeper into the numbers.
What is Home Mortgage Refinancing?
A home mortgage refinancing, or home loan refinancing, is basically the process of taking out a new mortgage with new terms and interest rate to pay off the existing home loan. You can either do this with your current lender or any lender. In general, it is a good idea to shop around to see who can give you the best rate and terms.
For example, you could go to companies like LendingTree to have several lenders compete for your loan to get the lowest mortgage rate or go to local banks. If you are a Costco member, they also have a program where you can connect with Costco approved lenders. Another good idea is to ask your Realtor® to provide you with lender recommendations.
Why You Might Consider Refinancing Your Home Loan
There are several reasons why refinancing might be right for you. Usually, people refinance their home for one or more of the following reasons:
- Lower your monthly mortgage payment — The main reason to refinance is to lower your monthly payment. This helps improve your cash flow, so that you’ll have more money available to do other things. You can lower your monthly mortgage payment by taking out a new loan at a lower interest rate, or by taking out a longer-term loan — i.e., refinancing the current loan with 20 years left to a new 30-year loan.
- Lower your overall costs — Another reason is to lower their borrowing costs by taking advantage of the lower interest rate. This is why more people are refinancing their home loans when interest rates are low.
- Reduce your risk — Refinancing can also be used as a risk management tool. For example, if your original home loan is an Adjustable Rate Mortgage (ARM), you could refinance to a Fixed Rate Mortgage to protect yourself against sudden rise in interest rates when the initial discount period expires.
- Raise cash — Refinancing can also be used to unlock your home equity and gain access to cash. This is called a cash-out refinancing. Specifically, you are taking out a larger loan than you currently owe and keeping the difference in cash — essentially borrowing more money against your home. Money raised from refinancing could be used for different purposes; for instance, for home renovation, to pay off high-interest debts such as credit card debts, to pay for major expenses, or investment purposes.
- Shorten your mortgage term — Refinancing isn’t always about lowering your monthly payment. If you are earning more than you used to, it may be worthwhile to covert your longer-term mortgage to a 15-year loan. This is generally better than prepaying the loan because 15-year loans have lower interest rates than a longer-term loan. This will help you pay off your home loan much faster and save you tens of thousands of dollars in interest payments.
- Eliminate Private Mortgage Insurance (PMI) — If your equity increased above 20% due to the rise in your home value, refinancing could be an option to get rid of your PMI if you can’t persuade your lender to drop the mortgage insurance. Getting rid of your PMI could save you hundreds every month.
The Best Time to Refinance Your Home Loan
Usually, the best time to refinance your home mortgage is when interest rates are low. Due to the costs associated with refinancing, the current interest rate should be at least 1% lower than the interest rate on your existing loan for refinancing to make sense.
Moreover, you may also consider refinancing your home if:
- Your creditworthiness — i.e., your credit score — improved enough to qualify for a better interest rate.
- Your financial situation changed significantly. For example, you want to lower your monthly payment because it’s straining your budget.
- Your Adjustable Rate Mortgage teaser rate is expiring, and you expect your interest rates to rise.
The Costs of Refinancing
However, it’s important to remember that refinancing is not a free lunch. There are closing costs associated with refinancing, similar to the closing costs that you paid when you first bought your home. Closing costs usually include fees related to survey, appraisal, title search, title insurance, realty transfer taxes, legal services, messenger or delivery services, document copying, etc.
You may also choose to pay points to get a reduced interest rate on your new loan. A point represents 1% of the total loan amount. For example, one point on a $100,000 mortgage costs $1,000. However, you are not required to pay points.
In essence, you are selling the house back to yourself all over again. As such, you have to stay in your home for a few years after refinancing to make it worthwhile. You can use this home refinancing calculator to help you determine your break-even point and see if refinancing makes sense for you. The rule of thumb is to refinance when you can recover the cost of refinancing within 24 months.
Refinancing Examples
Using this user-friendly mortgage calculator, I put together some scenarios to help you better understand when you should or should not refinance.
Mortgage Refinancing After 7 Years
| Original Loan | Refinanced Loan | Refinanced Loan | |
| New 30-yr Fixed | New 15-yr Fixed | ||
| Interest Rate | 5.000% | 3.875% | 3.25% |
| Balance | $439,725 | $439,725 | $439,725 |
| Monthly Payment | $2,684 | $1,975 | $3,144 |
| Saving | $710 | ($459) | |
| Month Remaining | 276 | 360 | 180 |
| Total Payment | $740,813 | $710,843 | $565,833 |
| Total Interest | $301,088 | $271,118 | $126,108 |
| Saving | $29,970 | $174,980 |
In this scenario, if you refinance right around year 7 from a 5% loan with 23 years left to a new 30-year 3.875% loan, you’ll save about $710 per month, and although you have to pay 7 years longer, you still net a saving of $29,970. Refinancing into a new 15-year loan at 3.25% will increase your monthly payment by $459 but shorten your loan by 8 years, and net you a saving of $174,980. Both of these scenarios indicate that it makes sense to refinance.
Mortgage Refinancing After 10 Years
| Original Loan | Refinanced Loan | Refinanced Loan | |
| New 30-yr Fixed | New 15-yr Fixed | ||
| Interest Rate | 5.000% | 3.875% | 3.25% |
| Balance | $406,710 | $406,710 | $406,710 |
| Monthly Payment | $2,684 | $1,913 | $2,908 |
| Saving | $772 | ($223) | |
| Month Remaining | 240 | 360 | 180 |
| Total Payment | $644,185 | $688,501 | $523,350 |
| Total Interest | $237,475 | $281,791 | $116,640 |
| Saving | ($44,316) | $120,835 |
In this scenario, if you refinance right around year 10 from a 5% loan with 20 years left to a new 30-year 3.875% loan, you’ll save about $772 per month, BUT you will extend your loan by 10 years and ended up paying $44,316 more. Refinancing into a new 15-year loan at 3.25% will increase your monthly payment by $223 but shorten your loan by 5 years, and net you a saving of $120,835.
Conclusion…do the math before you do a mortgage refinance.
NOTE: The math behind refinancing from an Adjustable Rate Mortgage (ARM) or to get rid of Private Mortgage Insurance (PMI) might be a little more complicated, and you might want to get a good mortgage lender to help you work through the numbers.
When Refinancing Does Not Make Good Financial Sense
Before I conclude this article, I want to say that mortgage refinancing is generally beneficial if done correctly and for the right reasons. However, there are things that you must watch out for and make sure that you do not refinance for the wrong reasons. For example:
- You may not want to refinance if your new mortgage payment will be more than 28% of your income. This will put too much strain on your cash flow.
- Think carefully before refinancing to consolidate unsecured debts (e.g., credit card balances, car loans, student loans, etc.). A home loan is a secured debt, and if you don’t change your spending habits in the process, you could end up losing your home.
- Do not refinance to buy depreciating assets, especially a car or electronics.
- Do not refinance to pay for non-essential expenses, such as a vacation or a wedding.
- Consider other options carefully before using refinancing your home to pay for your child’s college education.
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Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.
I’m looking to refinance and I’m just wondering about the appraisal. The bank wants me to put up $525.00 for that plus the other associated fees, but I’m scared. According to Zillow my house is worth $175,000, what I want to know is how close to this figure have the bank estimates been coming in. Just how does the appraiser get his figure? I asked the loan officer about calling in a real estate agent to appraise the house (just to see if I really wanted to take my chances and risk losing the $525.00) and he said that I… Read more »
There are a number of reasons why you may be interested in refinancing a home mortgage. For instance, if you are paying high rate of interest currently, you will certainly want to go for a home mortgage refinancing.
Another reason why people opt for a home mortgage refinancing is the fact that they want to get rid of mortgage payments more quickly. You can pay off your home mortgage loan much quickly by just adding an extra $100 to your monthly payments.
Great post and refinancing is big business now. I had friend who tried to refinance (getting a lender to call back is even hard!), and he was shocked to discover that with a 700 credit scrore he couldn’t qualify for the lower rates (even though he had 20%+ home equity)
@Kenneth – Thank you for your comment.
@Andy – I think it’s tougher right now due to the credit crunch and the economy. However, we do have record high refinancing rate right now. Also, may be your friend already has good rate?
A banker friend told me recently that almost all the loan transactions going on now are for home refinancing. Much like what you have pointed out…”we never know when the extra cash might come in handy”. Still we have a problem on having to take mortgage reducing term policies which cost a bomb the older we get. I understand that it is not compulsory, but these days the banks can afford to pick and choose. So even with low rates (still higher than those in the US, though), many of us find the cost of refinancing too high. You have… Read more »
Can a home be refinanced, having the mortgage balance plus a line of credit, which was used for the house’s renovation, rolled into the new mortgage?
How do I determine how quickly I would pay for the cost of refinancing a mortgage by reducing the interest rate. I currently owe about $134K with 13 years left at 4.38% fixed. I can get a 10 year at 3.25%. How can I tell if this is worth while to do considering the closing costs at $2,150?
@Douglas – I don’t know your original loan term and other aspects of your finances, so this is a guestimate at best. I estimated that you have to pay about $45k in interest payments to finish off your current loan. If you refinance to 10 years at 3.25%, that amount drops to about $20k. So refinancing is well worth the $2,150 closing costs if your goal is to reduce the overall loan costs. However, I don’t know what that means in term of the monthly payments. My estimate is that it will increase by about $200 a month. If that’s… Read more »
Watch out for any penalty or fees, they may be very high.
I currently have questions that need some answers. I have spoke to several refinance companies to grasp a feeling on which direction I should go. Some have told me to leave my loan the way it is and pay extra on top of it and others are more than happy to refinance me. My concern is that I plan to retire in the next 6-10 years. It is my understanding that when paying back on a loan, for the first several years most of your monthly payment goes to interest and very little to principle. I have been paying right… Read more »
@Mike – We can do the math together if you provide information about both loans, e.g., original loan amount, interest rate, term length, how long you’re already into the first loan, and closing costs.
Is there ever a time when you would endorse refinancing to pay off unsecured debt. I’m currently 9 years into a 30 year loan at 4.75% and owe 40K in credit card debt, most of which was spent on home improvements. I’m days away from closing on a 20 year loan at 3.75% for an amount equal to my current loan plus 40K. My payment will be $300 more a month. Pull the trigger or stand pat? I’d really appreciate your input.
Thank you Pinyo for your response. My current loan is at $102,000,@6.5% I have paid on it for approx. 10 years of a 30 year loan. The original loan was at 115,000. I’m currently looking at a loan for 15 years at 3.75-4%, unsure of closing cost and I have been told by my current lender that I will not have to pay for an appraisal.I plan to retire and sale the house if the economy has gotten better as early as 6 years and probably no longer than 10 years from now.Please let me know if you need additional… Read more »
I just got done refinancing my 6.375% Balloon, to a 3.75% fixed 30 year. it took over three months to get the approval, with a credit score above 770, with about 18% equity, and over 5.5 years at my job! Thank goodness it is over, but they required everything except my DNA profile before it got approved! My new payment is 30.00 more a month with all my taxes and insurances escrowed. where before I paid them yearly! A great deal, but more stress than anyone wants to go through. Patience Patience Patience if you decide to refinance!
At what point in a standard 30 year loan (say, at 7%) does it no longer make sense to refinance because you’ll end up paying more to interest on the 15 year than you have left in the 30 year?
I have a mortgage of slightly less than $40000 with a fixed rate of 5.5%. With today’s low rates, does it make sense to refinance a mortgage of this size? I have no other outstanding large debts and a credit score slightly over 800.
@Kevin – There is probably a formula for what you are asking for. Usually, I just plug in the numbers into a loan calculator and compare the difference.
@Doug – The answer depends on your original mortgage term, how long you’ve been paying the loan, the new interest rate and term length, and the estimated closing costs.
I currently owe about 8 years left of my mortgage (80,000) the interest rate is 6.5
Can I refinance? and is it worth it?
@Donna – Based on the very limited information. The answer is NO, if the orginal mortgage is 30-year; and possibly yes if the original mortgage is 15-year.
Question for you. I purchased my first home in Nov. of 09′ about two years in now. I took out a 30 year fixed rate of 5.25% FHA (currently paying PMI). I also qualified for the First time tax credit of up to $8K. Two questions. The first may be for a tax advisor, but I know I’m not allowed to sell the home or rent it out for the first 3 years. Does that also apply to refinancing? Second question (my main one) is: is it worth it for me to refinance at this point? I purchased the house… Read more »
Hi we have purchased our home in 2001 for $145,000 @5.25% I am looking to lower my monthly payments and are planning to live in the home about 10 more years. We are looking at a 10/1 arm @ 3.375 (no points), 20 year loan @ 3.752% (1 point) and 30 year @ 3.875%. All this information is getting me confused on which way to go. We are looking to save the most monthly IN ADDITION to resetting the clock back on our mortgage so we don’t pay all the extra interest. Can you help? Is there a way to… Read more »
@Dan – I believe you can refinance your FHA loan. There is even an FHA refinancing option. If you (1) can qualify for a much better rate, e.g., at least a point, (2) the closing cost is low and affordable, and (3) the new payment is substantially lower than the current payment, then refinancing might make sense. However, I don’t understand why/how you would make extra payments toward principal if you money is tight. Unless you mean making extra payment when you have money. @Donna – Assuming a 30-year loan, you’re probably paying about $800 a month on the Principal… Read more »
Hi I am thinking of refinancing. I bought my house in September 2009. My original loan was $149246 I have currently 27 years and 8 months left and my current balance is 144269.02. The current interest rate I have is 5.375%.
I am pondering refinancing to reduce my mortgage payment but I do not want to increase the length of my loan. Is that at all possible?
@Daniel – The shorter length products will not allow you to lower your monthly payment. Your options are ARM or 30-year fix. I personally can’t recommend ARM, but it might work well for some people. If you can get a better rate on the 30-year fix to lower the payment, you can always prepay some amount when you can afford to and shorten the loan length that way.
My wife and I are thinking of refinancing a $125,000 loan from 2008, which currently has a 6.25% rate, to reduce our monthly payments. We used to live there, but are now renting it out and living in another state, so don’t really have a lot of connection to the community re: local banks, etc. There are so many lenders out there, is one as good the next, as long as they’ll refi the loan the way we want it? I feel like I don’t know where to start with regards to institutions.