When you refinance a mortgage, you swap your existing home loan for a new one with terms that work better for you. Often, that means a lower interest rate on your new loan, though in some cases, that may not happen. For example, if you refinance to a mortgage with a longer loan term than your current mortgage, your rate could go up. But is refinancing worth it? Here's what you need to know.
It could be worth it to refinance your mortgage if you can save money on your monthly payment or on interest.
It's worth noting that refinancing isn't free. There are fees known as closing costs involved with refinancing a mortgage. Just as closing costs apply to a mortgage when you first buy a home, they also apply when you refinance.
But despite those closing costs, refinancing a mortgage could still help you come out ahead financially.
There are plenty of scenarios where it makes sense to refinance a mortgage. Depending on your situation, more than one of these may apply to you.
The lower the interest rate on your mortgage, the lower your monthly payment will be. If refinance rates have dropped due to market conditions, it could pay to apply for a new mortgage.
Say you're able to refinance from a $100,000, 30-year fixed mortgage at 3.75% to the same loan with an interest rate of 2.75%. By refinancing, your mortgage payment will go down by $54.64 a month. You'll also save $19,670 in interest over the life of your loan.
To see how much refinancing might save you, use a mortgage calculator to run the numbers based on your specific loan balance and term.
The higher your credit score, the more likely a mortgage lender is to offer you a lower rate on your home loan. If your credit score was mediocre when you first applied for a mortgage but has since risen substantially, your interest rate could drop a lot by refinancing.
Refinancing will often lower your monthly mortgage payment, but not always. If you refinance from a 30-year loan to a 15-year mortgage, you're likely to find that your monthly payment goes up, because you're now paying off your home in half the time. However, you could still reap major savings on interest throughout the life of your repayment period.
Usually, you'll get a lower interest rate on a 15-year mortgage than you will for a 30-year loan. Going back to our example above, refinancing that $100,000 mortgage to a 15-year loan at 2.35% will raise your monthly payment by $197.06 rather than lower it. But you'll also enjoy $47,825 in interest savings by repaying your mortgage loan in 15 years instead of 30. And, you'll be clear of your mortgage debt sooner. That's important if you're aiming to have your home paid off in time for a specific milestone, like retirement.
For more on refinancing to a 15-year mortgage, check out our guide on the topic.
Maybe you started out with a 15-year mortgage but are having a hard time affording your monthly payments. If that's the case, refinancing to a 30-year loan could result in a much lower monthly payment because you're now getting twice as long to pay off your home.
An adjustable-rate mortgage, also called an ARM, can save you money initially. Often, you'll get to lock in a lower interest rate on that loan for a preset period of time (for example, five or seven years). But once that initial period ends, your interest rate could rise.
If you refinance to a fixed loan, however, you'll lock in a guaranteed mortgage rate for the rest of your repayment period. That means you won't have to worry about your monthly payment rising over time.
For more on refinancing to a fixed rate mortgage from an adjustable-rate mortgage, our experts have put together a guide for you.
A cash-out refinance lets you borrow more than your remaining loan balance and use the extra money for any purpose. That might mean paying off debt, making home repairs, or financing home improvements.
Say your loan balance is $100,000. With a cash-out refinance, you might get a new home loan worth $120,000. The first $100,000 would be used to pay off your existing mortgage, and you'd then get a check for the remaining $20,000 to use as you please.
Note: You can do a cash-out refinance if your home is worth enough to cover the extra money you're taking out. If you owe $100,000 on your existing mortgage and your home is only worth $100,000, you won't qualify for a cash-out refinance.
Refinancing a mortgage can save you a lot of money, but only under the right circumstances. It doesn't pay to refinance when you won't be staying in your home long enough to reap savings once you break even from your closing costs.
Imagine you're charged $4,000 in closing costs to refinance and lower your monthly payment by $100. In that case, it will take you 40 months to break even and start saving money, so if you're planning to move in two or three years, it's not worth refinancing.
Similarly, refinancing isn't worth it if you can't snag a low enough interest rate on your new loan, because your savings may not be substantial enough to justify paying closing costs. Generally, it pays to refinance if you can lower the interest rate on your mortgage by 1% or more.
If you're going to refinance your mortgage, reach out to several refinance lenders and gather different offers to compare. You may find that one lender offers a lower interest rate on your refinance, lower closing costs, or both. The more offers you get, the easier it'll be to find the best deal.
Refinancing a mortgage is worth it when you can save money on either your monthly payment or on interest throughout your loan.
Refinancing is worth it when rates are competitive and you qualify for a lower rate than what you're paying, or when you need to change the terms of your loan.
You shouldn't refinance if you won't stay in your home long enough to break even from your closing costs, or when you can't lower your loan's interest rate by at least 1%.
We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team. The Motley Fool has a Disclosure Policy. The Author and/or The Motley Fool may have an interest in companies mentioned.
The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters.
Copyright © 2018 - 2021 The Ascent. All rights reserved.