4 Factors That Determine if Refinancing Makes Sense

Don't make the wrong decision when it comes to refinancing your home loan.

Mortgage refinance rates have been very competitive in recent months, although rates are no longer as low as they were during the early days of the pandemic when they fell to record lows. That said, refinancing a home mortgage when rates are low can be a smart move for many homeowners -- but not for all of them.

If you are considering refinancing, four factors can help you decide if this financial choice makes sense for you. Here's what they are.

1. The interest rate you can qualify for

Although average mortgage refinance rates are very low by historical standards, not everyone will qualify for a refinance loan at a rock-bottom rate.

Your individual financial credentials, including your credit score and income, will affect how much lenders charge you for a home refinance loan. If you can't qualify for a low rate because of your current financial situation, then refinancing isn't as attractive a proposition for you.

You can shop around and get quotes from several lenders to see what interest rate you might expect to pay if you refinance. This will help you make an informed choice about whether refinancing will save you money.

2. Your current interest rate

Your current interest rate on your home loan also plays a key role in determining whether or not you should refinance. That's because you only want to move forward with getting a new home loan if you can do so at a lower rate than you're currently paying. It would make no sense to refinance into a loan with a higher rate that costs you more money.

You do, however, also need to pay attention to whether your current rate is fixed or adjustable. If you have an adjustable-rate mortgage and your rate could change in the near future, then it may pay to refinance to a fixed-rate loan -- even if you can't drop your rate by much, or at all. That's because once your rate begins adjusting, you take a risk of ending up with really high interest costs and monthly payments.

3. How much closing costs are

Closing costs are upfront fees associated with refinancing. They cover things like your mortgage origination fee and an appraisal. And they can total thousands of dollars.

You need to know how much closing costs are so you can make sure you can afford to pay them for a refinance. While you can sometimes borrow for them, you'd need to have plenty of equity in your home to do that. And you'd ultimately make borrowing more expensive if you roll your closing costs into your loan since you'd be paying interest on that expense over time.

When you shop around and compare loan rates and terms, lenders should provide you with an estimate of your closing costs. This can help you decide if it makes sense to shell out so much money for a new home loan.

4. How long you'll stay in the house

Finally, the length of time you plan to stay in the house also affects whether refinancing makes sense. That's because you generally don't want to refinance unless you'll be in the home long enough to at least cover closing costs.

To take a simple example, say your closing costs were $5,000 and you would save $100 per month by refinancing your home loan. It would take you about 50 months -- or just over four years -- for the savings on your refinanced loan to cover your closing costs. If you were planning to move in two years, then refinancing probably wouldn't make sense.

Ultimately, if you consider these four factors, you can find out if refinancing will save you money in the long run. That will help you decide if a refinance loan is right for you.