When to Refinance Your Mortgage

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Knowing when to refinance is as important as knowing why. It’s true: Mortgage refinance rates are slowly rising but still relatively low, and if your original rate was locked in at a higher percentage point, you might be able to score a lower rate in the current pandemic-damaged economy. However, there are other factors to take into consideration. Jill Schlesinger, CBS news analyst and author of “The Dumb Things Smart People Do With Their Money,” says there are times when a mortgage refi is not in your best interest. Other experts weighed in as well.   

How Does Refinancing Work?

A mortgage refinance replaces your current mortgage with a new one. Typically, people refinance because they can get a lower interest rate or better terms on the new loan. You can choose to either use your current mortgage lender for the refinance or find a new lender. Like a new mortgage, a refinance usually comes with closing costs and fees that can amount to 3%-6% of the loan value.

When It’s a Good Idea to Refinance Your Mortgage

There are several reasons why refinancing might be a good idea. These include:

  • Getting a lower interest rate
  • Changing the loan term
  • Converting an ARM (Adjustable Rate Mortgage) to a fixed-rate mortgage
  • Tapping into equity or consolidating debt

Getting a lower interest rate

If you’re able to get a lower interest rate than your original mortgage — whether because of changes in the market or because you’ve improved your creditworthiness — refinancing can save you a significant amount of money. Current interest rates reached historic lows in the past year, and although trends show that they’re slowly rising, they’re still well below pre-pandemic rates. If you can get a lower interest rate than your current mortgage, you could potentially reduce your monthly payment and save thousands of dollars over the life of the loan.

Keep in mind that closing costs and fees for a refinance can run you a couple of thousand dollars, so do the math to make sure that your savings will outweigh the upfront costs. Know also that the refinance rate you get will depend on factors like your credit score and your debt-to-income ratio, so the low rates advertised may not be the rates you qualify for. Be sure to shop around with multiple lenders to find the best rates. 

Changing the loan term

Another reason to refinance is to change the loan term. You can shorten or extend the loan term. For example, refinancing from a 30-year mortgage to a 15-year mortgage or going from a 15-year mortgage to a 30-year mortgage. 

Shortening the loan term, which is more common, will raise your monthly payment but net you significant savings on interest in the long run because you’re paying off your loan sooner. You’ll also be able to build equity in your home faster. If you can afford the increased monthly cost, shortening your loan term can be a good deal.

On the other hand, extending your loan term will cost you more in the long run but can reduce your monthly payments. If you’re having trouble affording your monthly payments currently, extending your loan term can give you some breathing room. 

Converting an ARM to a fixed-rate mortgage

With a fixed-rate mortgage, you lock in an interest rate at the beginning of the loan and keep the same interest rate for the life of the loan. With an adjustable-rate mortgage (ARM), your interest rate is fixed for a certain amount of time and then adjusts based on the market rate at predetermined time intervals. For example, the interest rate on a 5/1 ARM will be fixed for the first five years, then adjusted annually for the rest of the loan. 

ARMs tend to offer lower interest rates than fixed-rate mortgages, making them a good deal in certain circumstances. But fixed-rate mortgages offer more stability in the long run since you don’t need to worry about interest rates changing unexpectedly. If you started off with an ARM but now prefer the stability of a fixed-rate mortgage, refinancing can let you change your mortgage type. 

Tap equity or consolidate debt

You can also tap into your home equity to get cash upfront with a cash-out refinance. A cash-out refinance lets you take out a new loan that’s larger than your current one, use the money to pay off your current mortgage, and receive the money left over in cash. Unlike a traditional refinance, a cash-out refinance will usually increase your monthly payment and interest rate since lenders are taking a bigger risk. In exchange, you’ll get money upfront to spend as you wish. A cash-out refinance could be a good option for those looking to finance home improvements or consolidate high-interest debt

However, since cash-out refinances are considered riskier loans, lenders often have stricter requirements. This is especially true in the current environment, where lenders are more selective about who they’ll lend to. This means that you’ll want a good credit score, a low debt-to-income ratio, and enough equity in your home to qualify. 

Pro Tip

If you are secure in your job and expect to be in your home for more than a few years, this is a great time to consider refinancing. “Any time you are going to be in your house for the foreseeable future and can save one half to three quarters of a percentage point on your interest payment, it’s worth considering,” says Greg McBride.

Is Refinancing Worth It?

There are several things to consider when deciding whether a refinance is right for your personal situation. Although market interest rates play a factor in how much you can save with a refinance, they shouldn’t be the only deciding factor. “If a refinance improves your situation, then go for it. If it doesn’t, don’t,” says Schlesinger. “Don’t try to time the market. If you can do this and save money, you don’t have to find the absolute bottom.”

If you are secure in your job and expect to be in your home for more than a few years, right now is a great time to consider refinancing because of relatively low interest rates. “Any time you are going to be in your house for the foreseeable future and can save one half to three-quarters of a percentage point on your interest payment, it’s worth considering,” Greg McBride, CFA, chief financial analyst for Bankrate.com.

But there are also situations where refinancing might not be a good idea. Schlesinger says those  moving in the next few years won’t be in their homes long enough to make up for the expenses incurred during the refi. “Let’s say that I am saving $100 a month, but the whole refi process cost me $5,000,” she says. “It’s going to take a while for me to recoup my savings.” You’d be saving $1,200 a year in Schlesinger’s example, but if you move in two years, you’ll only have recouped half of the refi costs.

McBride, meanwhile, says you should avoid trying for a refinance if you find yourself unemployed, no matter how appealing it might be to have a lower mortgage payment. “Banks probably won’t consider you for a refinance if you’re out of work,” he says. 

It’s also important to consider your credit rating, McBride says. Your ability to score a new mortgage at a lower interest rate is dependent on your credit history. If you have a low credit rating, you may not qualify for a refinance rate worthy of savings.

How Long Does It Take to Recoup the Costs of Refinancing?

Let’s assume you’re trying to decrease your monthly payment on your mortgage. You owe roughly $100,000, and your current interest rate is 4.875%, with 15 years left to go on a 30-year mortgage. After some research, you find a lender offering a refinance rate of 3.29% on a 15-year fixed rate. Here’s how the numbers might run:

Monthly Payment at 4.875%$850
Monthly Payment at 3.29%$704.61
Monthly Difference$145.39
Yearly Difference$1,744.68
10-year Difference$17,446.8
15-Year Difference$26,170
Approximate cost of refinance [One point: $1,000, Application fee: $65, Attorney’s fee: $200, Appraisal fee: $150, Document preparation: $50, Local fees: $200, Title search: $65]$1,830
Months to recoup costs12.59
Try NextAdvisor’s Refinance Calculator to see your potential savings.

How Long Does It Take to Refinance a Mortgage?

The time it takes to refinance a mortgage will vary depending on your location and personal situation but generally runs between 15 to 45 days. You’ll generally have to go through the application and underwriting process, home inspection and appraisal, and closing process. If you run into unexpected issues during any of these steps, the wait time can be even longer.