These 2 Factors Determine if Refinancing Will Save You Money

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KEY POINTS

  • Refinancing means getting a new loan to repay your existing home loan in full.
  • There are two factors that determine if refinancing will end up saving you money in the long run. They include interest rate and repayment time.


You need to look beyond the interest rate.

Repaying your mortgage can take decades, and it means spending thousands of dollars in interest costs over time. The good news is, there are techniques you can use that may make repayment cheaper and easier. Refinancing is one of those techniques.

When you refinance your mortgage, you apply for a new loan. This could come from your existing lender or from another bank, credit union, or online lender. The proceeds from the new loan repay your old mortgage in full. You'll then work on paying down the new mortgage debt.

Refinancing can often save you money, but that's not always the case. There are two big factors that will determine if securing a mortgage refinance loan is a good financial choice that will make the repayment process cheaper -- or if you should stick with the status quo and keep paying on your current loan instead of getting a new one. Here's what they are.

1. The interest rate on your new loan vs. your old one

The first big factor that affects whether your refinance loan will save you money is the interest rate the lender charges you. If you can lower your interest rate, you'll often end up better off by refinancing since this rate controls the cost of borrowing.

Whether you can lower your interest rate depends on many factors. If you have improved your credit score and you have more solid financial credentials than when you first applied for your home loan, you may be able to qualify for a lower rate. Likewise, if you took out your mortgage when national average rates were higher than they currently are, it's possible you'll be able to drop your rate.

The only way to tell if you'll be able to get a lower rate refinance loan is to shop around with different mortgage refi lenders. You can generally get a refinance quote without a hard inquiry that could damage your credit score, and you should consider getting several quotes to see if you can find a rate that's significantly lower than what you're currently paying.

While dropping your interest rate even by a relatively small amount could theoretically save you money, you do need to remember there are upfront closing costs to pay when you refinance. As a result, you'll usually find it's worth refinancing only if you can drop your rate by at least 1 percentage point -- although your situation may vary, so it's a good idea to look at how much you'd save each month versus the upfront fees you'd pay.

2. Your repayment timeline on your new loan vs. your old one

While the interest rate on your new loan plays an important role in determining if you'll save, it's not the only factor that affects whether your refinance loan is more or less expensive. Your repayment timeline matters as well.

Often, when you refinance, your new loan will take longer to be paid off than if you'd stuck with your current mortgage. That's because many people refinance into a 30-year loan, but they may have originally started with a 30-year loan and have been paying it for a while. Say, for example, you have a 30-year fixed-rate mortgage you've paid on for five years already. If you get a new 30-year loan, you end up in debt for an additional five years.

The longer you pay interest, the higher your total costs, so if you extend your repayment timeline too much, refinancing could result in a lower rate and monthly payment but higher total costs over time. Your lender should give you a quote that includes an estimate of total payoff costs, and you can compare that to your current loan to see if refinancing will end up providing savings over time.

Considering both the interest rate and payoff time can help you make a fully-informed choice about whether refinancing is right for you. Since your mortgage is such a large debt, it's worth taking the time to understand your options completely before moving forward with a refinance loan.

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