Mortgage

How to Decide Whether a Mortgage Refinance Is a Good Idea

The thought of refinancing your mortgage can be enticing—a lower interest, reduced payments or a shorter loan term could make it easier to pay back your loan and even save you money. But whether a mortgage refinance is a good idea will depend on a few factors—how can you be sure it's right for you?

Refinancing is when you use a new loan to pay off your existing mortgage loan, often with the goal of getting a better interest rate, improved terms or a shorter repayment period. It's a major financial decision and a step you should only take when you know the timing and circumstances are right.

Read on to learn about when refinancing is a good idea, and to see if getting a new home loan is the right move for you.

Why Would You Want to Refinance?

Before you pull the trigger on refinancing, think about why you want to do it. There are many reasons to refinance, including to reduce your monthly payment or to get a cash infusion, but it's important to make sure it's worth the time, paperwork and potential cost.

The following are some of the most popular reasons people refinance:

  • To lower their interest rate
  • To shorten the life of their loan
  • To obtain cash with a cash-out refinance

Refinancing can help you achieve these goals and ultimately give you more options when it comes to your finances. Think about your situation and needs, and do your research to determine if refinancing your mortgage is the best option on the table.

Is Now the Best Time to Get a New Interest Rate?

Many people are attracted to refinancing because of the potential savings that come with a lower interest rate. But for those savings to actually occur, the interest rate on your new loan will have to be lower than the rate on your existing mortgage by enough to at least offset refinancing fees.

Mortgage rates are set by lenders, but they can be affected when the Federal Reserve changes its benchmark interest rate. When the Fed lowers rates, mortgage lenders may in turn lower their rate. Similarly, when the Fed increases rates, mortgage rates can go up.

Though changes to the Fed rate have stimulated mortgage rate fluctuations in the past, it's not guaranteed that one will lead to the next. Ultimately, it's possible the new rates lenders begin to offer will be lower than the one you have on your current loan. When you see that lenders are offering lower rates—whether because of a Fed rate change or something else—that could indicate that refinancing could be a good move.

To see if lenders are currently offering low interest rates, you can do research online or contact a mortgage broker. You can also call your bank to see if they can give you an idea of what interest rates they are offering for refinancing loans.

To illustrate the potential savings you might see by refinancing, let's imagine you refinance your 30-year mortgage after 15 years of repayment and an outstanding balance of $100,000. Your previous loan had an APR of 4%, and by refinancing you're able to drop your APR to 3.5%.

If you continued to pay for the next 15 years at 4% APR, you would end up paying roughly $33,000 in interest over that time. By lowering your APR to 3.5%, the total paid in interest would be around $28,000—a savings of $5,000. Just keep in mind you'll need to take loan fees into account to determine your net savings.

How Will You Know if Refinancing Is Worth It?

Since refinancing can change your overall cost or how long it takes to repay your loan, you need to understand exactly what your mortgage will look like once the process is done.

  • If it's money savings you're after, find out how long it'll take you to break even on your refinancing fees (closing costs) that could cost 2% to 6% of the loan amount.
  • If you're refinancing to reduce the repayment term, calculate how much your new monthly payment will be and how long you'll be paying it.
  • If you're doing a cash-out refinance so you can make a purchase or pay off debt, do the math to see if a refinance makes more sense than the alternatives such a credit card or debt consolidation loan.

Taking the time to determine your costs or savings will help you see if refinancing is worth it. When you lay it all out, you may ultimately find that a refinance isn't worth the effort.

How to Get Cash With a Refinance

If you need cash for other purchases or to pay down other debts, you may be considering a cash-out refinance. With this, you take out a loan that's larger than your current mortgage, and use the cash you have left over after paying off your existing home loan to handle your financial needs.

A cash-out refinance could cause your monthly payment to increase, so this option is really only advised for people who need this option to get some fast cash.

Should You Refinance if You're Moving Soon?

If you have plans to sell your home relatively soon, think twice before refinancing. Due to the fees associated with processing a mortgage, you should do the math to figure out how long you'll need to pay down your new mortgage before you sell. Selling your house before you've broken even on loan fees can neutralize your savings.

If you plan on getting a mortgage on a new home, you can use that opportunity to negotiate better interest rates and terms on your new loan. Refinancing right before you sell a house may only result in extra costs with few benefits.

When Should You Stick With Your Current Mortgage?

If you've considered the factors above and don't immediately see a benefit to refinancing, you should most likely stick with your current mortgage. Again, refinancing is not something you should do just for the sake of doing it. You should be able to clearly see the benefit—whether it's monetary savings, a reduced repayment period or something else.

Check Your Credit Before Refinancing

No matter what your reason for refinancing, you should check your credit reports and scores before applying. Lenders will base your interest rate, in part, on your creditworthiness, and making sure your credit is in a good place could help you lock in a low rate.

Having a good credit history and score could give you extra leverage when negotiating with lenders, ultimately helping you get the best terms for your new loan. If you'd like to check your credit, consider getting a free copy of your credit report and FICO® Score from Experian to see what lenders might consider when evaluating you for a loan.