When to Refinance a Mortgage: Is Now a Good Time?
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Sure, when interest rates are dropping, mortgage refinance tends to be in the news. But falling interest rates aren't the only reason it might be the right time to refinance your mortgage.
Keep reading to learn more about what you should consider before refinancing and different scenarios that might lead you to refinance your mortgage. Then you’ll be better equipped to decide if it's a good time for you to refinance.
What to know before you refinance
No matter your reason for refinancing, you're going to want to figure out a few numbers before you apply.
Your current interest rate. Take a look at your most recent mortgage statement to confirm your mortgage interest rate. Since even small fractions of a percentage point can really add up, it's important to know the real number, not just "about 6%." If rates have decreased, you can figure out how much you'd save. But if rates have increased, consider whether the other benefits of refinancing are worth the additional interest.
An estimated amount for your refinance. Whether you'd simply be refinancing the amount left on your mortgage or you're looking to take out a larger loan, keep that sum handy, too. Refinancing comes with closing costs, which usually run between 2% and 6% of the amount of the new loan. Knowing how much you'll be borrowing allows you to estimate those costs.
How long you plan to stay in the house. If your goal is to save money by refinancing, you need to figure out your break-even point. That's when your savings from refinancing is larger than the amount you spent on closing costs. For example, if you pay $3,600 in closing costs to save $100 a month, it will take 36 months to break even ($3,600 divided by $100 equals 36). To make back that money in savings, you'll need to stay in the home for at least three years after your refi.
» MORE: Calculate your refinance savings
You might get a better mortgage rate by refinancing
Homeowners refinancing to get a better mortgage rate usually opt for a rate-and-term refinance. But since any refinance will change your interest rate — after all, you're replacing one mortgage with an entirely new one — the effect on your mortgage rate should always be a consideration.
An often-quoted rule of thumb says that if mortgage rates are lower than your current rate by 1% or more, it might be a good idea to refinance. But that's traditional thinking, like saying you need a 20% down payment to buy a house. Such broad generalizations often don't work for big-money decisions. If you could get a half-point improvement in your interest rate, refinancing could make sense.
Avoid focusing too much on specific mortgage rates that you read about or see advertised. Mortgage refinance rates change throughout the day, every day. And the rate you’re quoted may be higher or lower than a rate published at any given time. You’re more likely to get a competitive rate if your credit score is good, and you have proof of steady income. If your credit could use work, it may make more sense to build it up before refinancing.
To determine if refinancing would save you money, it's a good idea to run the real numbers with a mortgage refinance calculator.
To calculate your potential savings, you’ll need to add up the costs of refinancing, such as an appraisal, a credit check, origination fees and other closing costs. Also, check whether you face a penalty for paying off your current loan early. Then, when you find out what interest rate you could qualify for on a new loan, you’ll be able to calculate your new monthly payment and see how much, if anything, you’ll save each month.
Once you have a good idea of the costs of refinancing, you can compare your “all-in” monthly payment with what you currently pay. And again, think about the break-even point. If you’re close to starting a family or having an empty nest and you refinance now, there’s a chance you won’t stay in your home long enough to break even on the costs.
» MORE: Best lenders for refinancing
You could save by changing your home loan's term
When you're refinancing, in addition to getting a new interest rate, you can also change the term, or length, of your mortgage.
When they can afford it, many people refinance from a 30-year to a 15-year loan. Paying off your loan over a dramatically shorter amount of time usually means significantly higher monthly mortgage payments, but it can also substantially lower the amount of interest paid over the life of the loan.
You can also refinance to a longer term. That can lower your monthly payments, because you're paying over more time. But you're also paying more interest because you've extended the life of the loan.
If you’re already 10 or more years into your loan, refinancing to a new 30-year or even 20-year loan — even if it lowers your rate considerably — will tack on interest costs. That’s because interest payments are front-loaded; the longer you’ve been paying your mortgage, the more of each payment goes toward the principal instead of interest.
You don't have to change the term, though — you can opt to refinance to the same payoff date as your current loan. That strategy can be useful when you want to pay off the mortgage by a certain deadline, like before you retire. For example, if your 30-year mortgage is exactly five years old when you refinance, you can request to pay off the new loan in 25 years. Ask the lender to amortize the mortgage for 25 years (or whatever number of years you wish).
Ask your lender to run the numbers on different scenarios so you can see how your costs might change depending on your loan's term.
You want a different type of home loan
Refinancing can allow you to change your mortgage type, which can be helpful if the home loan you started out with is no longer the right fit for you.
Let’s say you bought a home with an adjustable-rate mortgage for an initial term of five years at around 6%, and you aren't looking to move. If you’re nearing the time when the adjustable rate can reset and move higher, you might benefit from refinancing to a fixed-rate mortgage to get an interest rate that won’t fluctuate.
Or, if you know you’ll be moving in a few years, refinancing to an ARM from a longer-term fixed loan might help you save some money because lenders usually offer lower interest rates during the initial fixed period on those loans.
If you have an FHA loan, you're likely paying FHA mortgage insurance — and unlike private mortgage insurance, FHA insurance doesn't typically go away because you gained more equity. Maybe you now have at least 20% equity, and since you've been steadily paying your mortgage, you've improved your credit score. You could qualify to refinance into a conventional mortgage without needing private mortgage insurance.
In that scenario, you potentially save money by getting a better interest rate thanks to your stronger credit score, as well as eliminating your mortgage insurance bill.
You can tap equity with a refinance
If your home has grown in value or you've paid down a significant amount of your existing mortgage — or both, lucky you — you may be sitting on a substantial cushion of home equity. Home equity is the difference between your home's current value and what you still owe on your mortgage. If you have sufficient equity, you could use a cash-out refinance to convert some of your home's value into, well, cash.
To do that, you refinance into a new mortgage that's for more than you owe on your current mortgage. The cash you get comes from the difference between that new mortgage amount and what you currently owe. Lenders usually require you to maintain at least 20% equity in your home, limiting the amount you can borrow.
A cash-out refinance sounds great, since it's turning some of your wealth into actual money you can spend. But cash-out refinances should be used with caution. Because you're taking out a larger loan, your mortgage payments may be higher even if you're getting a lower interest rate. If interest rates have gone up, you could be hit with the double whammy of a higher interest rate on a larger loan. It's vital to be sure that your budget can handle those bigger payments.
If you're looking to use home equity but hesitant about losing your low mortgage interest rate, a second mortgage might be preferable to a cash-out refinance. With a home equity line of credit or a home equity loan, you don't alter the terms of your current home loan.
You need to add or remove a borrower
Formally adding or removing a borrower from your mortgage changes the terms of your loan, so you generally need to refinance so you've got a new loan with new borrowers. (The one frequent exception is if a co-borrower is deceased.) If you're adding a borrower, you'll want to be sure that person is a strong loan applicant. Their income, credit score and basic financials should be solid, since they'll need to stand up to underwriting. While having the extra income from an additional borrower can help strengthen your overall financial position, you don't want their low credit score, for example, compromising the interest rate you're offered.
You can always add another person to your home's title without adding them to the mortgage. Having their name on the title gives them legal claim to the home even if they aren't obligated to pay for it. You might have a formal or informal agreement that they'll pay toward the mortgage, but from your lender's point of view, that other person isn't responsible for paying the mortgage if they aren't listed as a borrower. This can be a decent option if you want to share ownership with a new spouse or partner but don't want to change the terms of your current home loan.
Removing a borrower requires refinancing, because you have to work with a lender to get someone off your mortgage. This can get tricky, because if one person is keeping the property, that person will need to be able to qualify for the refinanced property without the co-borrower. If that's not an option for either party, the home may need to be sold.
Also worth noting: When the proceeds are being used to buy out one borrower's interest in a home, many lenders will treat a cash-out refinance as a rate-and-term refinance. That can be helpful, because rate-and-term refinances tend to come with lower interest rates than cash-out.
