3 Reasons It Pays to Refinance a Mortgage

Should you refinance your home loan? It could be a smart move.

Read the news today, and you'll see that homeowners are clamoring to refinance. With mortgage rates at historic lows, there's much to be gained by swapping your existing home loan for a new one. Here's why refinancing might make a lot of sense for you.

1. You could slash your monthly payment

Your goal in refinancing should be to snag a lower interest rate on your mortgage than the one you currently have. And, of course, the wider the gap between your current interest rate and your new rate, the more money you'll save.

Imagine you have $150,000 left on your mortgage and you're paying 4% interest. That means a monthly payment of about $716 (that's principal and interest on your loan; it doesn't include property taxes, HOA fees, or other recurring expenses you might factor into your monthly housing payment). If you manage to refinance at a 3% interest rate, you'll knock your monthly payment down to $623. That's $1,000 in yearly savings. (If you want to see how much you might save by refinancing, you can use this handy calculator.)

2. You could shorten the life of your loan -- and reap savings on interest

Refinancing won't always lower your monthly mortgage payment. For example, if you refinance a 30-year mortgage into a 15-year loan, you'll likely see your monthly payment go up. But it could still pay to go that route because you'll shorten your repayment period. That will not only help you shake your housing debt sooner, it will save you money on interest.

Let's say you're looking at a 30-year, $150,000 mortgage at 4% interest with a monthly payment of $716. That loan will cost about $108,000 in total interest. Let's say you can refinance into a 15-year loan at 2.75% interest. Your monthly payment climbs to about $1,018 because you're giving yourself less time to pay off that loan, but you'll wind up spending around $33,000 on interest -- not $108,000.

3. You can capitalize on a much-improved credit score

A big factor mortgage lenders take into account when deciding what interest rate you qualify for is your credit score. The higher it is, the more favorable a home loan you're likely to snag. If your credit score was just okay when you got your initial mortgage but it's since improved a lot, you may be eligible for a much lower rate now. And the lower your rate, the lower your associated costs.

Of course, there are some situations where refinancing a mortgage doesn't make sense. If you're not able to lower your interest rate all that much, then it could pay to stick with your existing home loan. There are closing costs associated with refinancing, so as a general rule, your goal should be to slash your interest rate by about one percentage point (or more, if possible). If you can't pull that off, then refinancing may not be the best move.

Similarly, if you're not planning to stay in your home for more than a year or two, you may not recoup the closing costs to refinance, so keeping your old loan may be the better choice. But often, refinancing is a move that works out well for homeowners, and given today's rates, it could pay to pursue it.