When should you refinance your mortgage?

Deciding when to refinance your home depends on various factors, including current market conditions, your financial goals, and individual circumstances.

The average cost to refinance a mortgage typically ranges from 2% to 6% of the new loan amount in closing costs.₁ These costs can vary based on factors such as the size of your loan and your location. the typical closing costs associated with refinancing a mortgage. Let’s summarize it:

• Application Fee: Can range from $75 to $500.
• Origination and/or Underwriting Fee: Typically 0.5% to 1.5% of the loan principal.
• Recording Fee: Varies based on location.
• Appraisal Fee: Around $300 to $400, or higher for larger properties.
• Credit Check Fee: Usually $30 or less.
• Title Services: Typically $700 to $900.
• Survey Fee: Ranges from $375 to $750.
• Attorney/Settlement Fee: Usually $500 or more.

Considering these costs, it’s important to calculate the breakeven point – the moment when the savings on your new mortgage surpass the upfront cost. Various factors, such as your credit score, lender, type of refinance, loan size, and property type, affect the interest rate. To assess whether refinancing aligns with your financial goals, you can use tools mortgage refinance breakeven calculator.

To mitigate the cost of refinancing, improving your credit score, comparing mortgage terms and rates, and negotiating closing costs can be effective strategies. Ultimately, it’s crucial to weigh the potential savings against the upfront expenses to make an informed decision about refinancing.

Considerations Before Refinancing:

Negative Credit Impact: When you refinance, your original loan is closed, which decreases the overall age of your credit accounts. This can cause your credit score to dip temporarily.

• Example: If you’re planning to apply for a major loan (like an auto loan) soon, the credit score drop could affect your eligibility and interest rates.

Closing Costs: Refinancing involves closing costs, including application fees, origination fees, appraisal fees, and more. These costs can add up and impact the overall financial benefit of refinancing.

• Example: If the closing costs are substantial, it might take several years to recoup the expenses through lower monthly payments.

Potential Prepayment Penalty: Some mortgage agreements include a prepayment penalty for paying off the loan early. Refinancing could trigger this penalty, resulting in additional costs.

• Example: If your existing mortgage has a prepayment penalty clause, carefully evaluate whether refinancing is worth it.

Reduced Home Equity in a Cash-Out Refinance: In a cash-out refinance, you borrow more than your existing mortgage balance and receive the excess as cash. However, this reduces your home equity, which may impact your financial security.

• Example: If you need the cash for essential expenses, weigh the trade-off between equity and immediate financial needs.

More Interest Paid with a Longer Term or Bigger Loan: Extending the loan term (e.g., from 15 years to 30 years) can reduce monthly payments but result in more interest paid over time. Similarly, borrowing a larger amount (e.g., for home improvements) increases the total interest paid.

• Example: Consider the long-term cost implications before refinancing for a longer term or a larger loan amount.

When Should You Refinance Your Mortgage?

Here are some common situations in which refinancing might be beneficial:

Lower Interest Rates:

If market interest rates have dropped significantly since you obtained your original mortgage, refinancing to a lower rate can reduce your monthly payments and save you money over the life of the loan.

Reason: Refinancing is beneficial if you can secure a lower interest rate or extend your loan term.

Example:

• Original Loan:
  • Mortgage Balance: $300,000
  • Interest Rate: 4.5%
  • Monthly Payment: $1,520
  • Refinanced Loan (Interest Rate Reduced to 3.5%):
  • New Monthly Payment: $1,347
  • Savings: $173 per month

Improved Credit Score:

If your credit score has improved since you initially obtained your mortgage, you may qualify for better interest rates, making it a good time to refinance.

For example, if your credit score has increased significantly since you first purchased your home, you may now qualify for a lower interest rate on a refinanced mortgage. This lower rate could result in reduced monthly payments and long-term savings on interest payments.

Switching from Adjustable to Fixed Rate:

If you currently have an adjustable-rate mortgage (ARM) and want more stability in your monthly payments, refinancing to a fixed-rate mortgage can provide predictability and protection against future interest rate increases.

• Reason: Refinancing to a fixed-rate mortgage provides stability if you currently have an adjustable-rate mortgage (ARM).

Example:

• Original ARM:
  • Variable Interest Rate: 3.5%
• Refinanced Fixed-Rate Mortgage:
  • Fixed Interest Rate: 4.0%
  • Benefit: Predictable payments throughout the loan term

Accessing Home Equity:

If you’ve built up equity in your home, refinancing can allow you to access some of that equity for home improvements, debt consolidation, or other financial needs.

Reason: Refinancing lets you tap into your home’s equity for purposes like home improvements or debt consolidation.

Example:

• Original Loan:
  • Home Value: $400,000
  • Mortgage Balance: $250,000
  • Available Equity: $150,000
  • Refinanced Loan (Cash-Out Refinance):
  • New Loan Amount: $280,000
  • Cash Received: $30,000
  • Use: Home renovations or paying off high-interest debt

Removing Private Mortgage Insurance (PMI):

If you originally purchased your home with less than a 20% down payment and are paying for private mortgage insurance, refinancing may be an option once you have sufficient equity to eliminate PMI, which can lower your monthly payments.

• Reason: Refinancing allows you to drop private mortgage insurance (PMI) if you’ve built sufficient equity.

Example:

• Original Loan:
  • PMI Cost: $150 per month
• Refinanced Loan (No PMI):
  • New Monthly Payment: $1,347
  • Savings: $150 per month

Consolidating Debt:

Refinancing can be a way to consolidate high-interest debt, such as credit card balances, into your mortgage at a lower interest rate, potentially reducing your overall monthly payments.

Shortening the Loan Term:

Refinancing to a shorter loan term, such as switching from a 30-year to a 15-year mortgage, can help you pay off your home faster and save on interest payments in the long run, though it may increase your monthly payments.

Consider Closing Costs:

When contemplating refinancing your mortgage, keep in mind the closing costs involved. These expenses, such as application and origination fees, can impact the overall financial benefit of refinancing. Assess whether potential savings outweigh these costs and calculate the breakeven point to make an informed decision.

Reason: Refinancing involves closing costs (e.g., origination fee, appraisal fee).

Example:

• Closing Costs: $6,000
• Monthly Savings from Refinancing: $173
• Break-Even Point: Approximately 35 months

Learn more : FHA Closing Cost

Bottom line:

It’s important to carefully consider the costs associated with refinancing, such as closing costs and fees, and calculate the breakeven point to determine whether refinancing makes financial sense for your situation. Additionally, consulting with a financial advisor or mortgage professional can provide personalized guidance based on your specific needs and goals.