3 Questions to Ask Before Refinancing

Make sure refinancing is the right move by answering these three questions.

Refinancing your home mortgage can be a smart financial choice in many circumstances. But it's not the right decision for everyone.

If you're trying to decide whether to refinance your loan, there are three big questions to ask yourself to see if it makes sense to move forward. Here's what they are:

1. How much will you save?

Refinancing should save you money, Otherwise, you'd be better off sticking with the loan you already have.

Ideally, you'll both save on your monthly payment and save on total interest costs. Both the mortgage refinance rate and the repayment timeline on your refinance loan will determine how much (if anything) you save each month and over time.

If you choose a shorter repayment timeline, your monthly payments may stay the same or go up -- even if you can drop your interest rate. But you'll save a lot over the life of the loan. By contrast, if you make your payoff time longer, you can drop your monthly payment by a lot if you also qualify for a loan at a reduced rate. But you may not save much over time or could even end up paying more in total interest over the life of the loan since you'll be making interest payments for a longer period of time.

You should compare loan options, ideally with several lenders, and look for a loan that provides a good balance of short-term and long-term savings. A mortgage calculator can help you explore exactly how each potential loan will compare with your old one.

2. How much are closing costs?

There will always be closing costs for refinancing a home loan. That's true even if you get a loan with no up-front fees. With these types of loans, refinance lenders generally either raise your interest rate or simply allow you to increase your loan amount so the loan covers the closing fees.

Understanding how much your closing costs are will help you see if refinancing is actually worth it. After all, paying a large up-front fee -- which typically totals thousands of dollars -- is a smart move only if you benefit financially from doing so.

Lenders are required to provide a summary of estimated closing costs when you apply for a home loan. You can use this to help you compare loan options and see how much you'll pay in fees to get a new mortgage.

3. How long do you plan to stay in your home?

Finally, the last key question to figure out is how long you're going to stay in your home. And that matters because you want to make sure the savings you achieve from refinancing will cover the closing costs you'll pay to secure your new loan.

Say, for example, refinancing saves you $75 per month in payments but you have to pay $6,000 in closing costs to get your new loan. It would take you 80 months, or about 6.7 years, for the savings to cover the closing costs. If you're going to move in two years, it probably doesn't make sense to move forward with a refinance loan.

Ultimately, by looking at the big picture, you can decide what the right course of action is. Hopefully, you'll find that you can qualify for a competitive new loan with affordable closing costs that makes refinancing well worth it. But unless you're confident that's the case, you should think twice about going through the trouble.

For more information, check out our guide on how to refinance your mortgage.