At some point, many homeowners decide to refinance their mortgage, meaning they replace their original mortgage with a new one. Refinancing can help you reach a variety of financial goals, such as lowering your monthly payment, paying off your loan sooner or paying for home improvements. However, refinancing isn’t always a smart financial choice.
Wondering if and when to refinance? We’ll explore the top reasons to refinance a home loan – and the reasons not to do it – to help you decide whether it’s a good idea for you.
Key Takeaways:
- Refinancing your house means replacing your current mortgage with another mortgage – often to save money in the short or long term.
- Lowering your mortgage interest rate, changing your term or loan type, tapping into home equity, and cancelling mortgage insurance are some of the best reasons to refinance.
- Refinancing doesn’t always make financial sense, especially if your credit has dropped, interest rates have risen, you plan to move soon or your existing mortgage is almost paid off.
- If you’re deciding when to refinance, consider how much a refi will cost versus how much you’ll save. If you sell your home before breaking even, refinancing now may not be worth it.
The 5 Best Reasons To Refinance Your Mortgage
When you refinance a home loan, you replace your existing mortgage with a new one that typically has different loan terms. Read on for the specific reasons you may want to refinance your mortgage, and what to consider.
1. To Lower Your Mortgage Interest Rate
Lowering your mortgage interest rate has a major appeal: It can save you money on both your monthly mortgage payment and your total loan cost. The lower your interest rate is, the lower your monthly payment will be and the less you’ll shell out in interest over the years. If interest rates have dropped or your credit has improved since you took out your home loan, you may be able to qualify for a lower rate.
Here’s an example of how much you can save by lowering your interest rate by one percentage point when you’re 10 years into a 30-year loan. Assume your original loan was for $300,000:
| Interest Rate | Monthly Payment | Total Interest | |
|---|---|---|---|
| Original Loan | 7% | $1,995.91 | $221,580.65 |
| New Loan | 6% | $1,844.36 | $185,209.18 |
In this scenario, refinancing would save you $36,371.47 by the time your loan is paid off (excluding the cost of refinancing).
Refinancing to a lower mortgage rate can also help you build home equity faster. Your equity grows as you pay down the principal balance of your mortgage. Depending on the new terms and how many years you had been paying down your previous mortgage, a lower interest rate may mean that you will now be paying more toward your loan’s principal each month. This helps you build equity in your home more quickly.
2. To Change Your Loan Term
Changing your loan term can be appealing, whether you want to save money now or over the long term. Doing so can help you pay off your loan faster, saving money down the road or lower your monthly payment by spreading the cost over a longer term.
Let’s see what happens when you shorten or lengthen your mortgage term.
Shortening The Loan Term
Refinancing to a mortgage with a shorter term – like switching from a 30-year mortgage to a 15-year mortgage – can help you pay off your mortgage early. You’ll own your house sooner, and an early payoff can free up cash for other financial goals. Choosing a shorter loan term can also help you save money on the total interest you pay over the life of the loan. (Plus, 15-year mortgages often come with lower interest rates.)
However, switching to a shorter-term loan typically increases your monthly payment amount. If you’re struggling to make your mortgage payments, shortening your term may not be wise.
Lengthening The Loan Term
Refinancing with a longer loan term lowers your monthly mortgage payments because you’re extending the amount of time you have to pay back the loan. These lower monthly payments can free up funds in your budget to pay off other debts, build up your savings account or invest.
Keep in mind, however, that while your monthly payments will be lower, you’ll actually pay more in total interest over time. It will also take longer to own your property outright. However, if you’re struggling to make on-time mortgage payments, it’s usually better to be proactive about addressing the issue to avoid foreclosure.
3. To Access Your Home Equity
A cash-out refinance replaces your current mortgage with a new, larger loan so that you can borrow from the equity you’ve built. (Equity is the amount of your home you own, or your home’s value minus what you owe.) After paying off your previous mortgage with a larger loan, you’re left with a lump sum of cash, which you can use in a variety of ways. For example, you might pay off high-interest debt, bolster your emergency fund or make home repairs or improvements.
If you refinance to tap your home’s equity, just be aware that you are still taking on more debt. This means you’ll have a larger loan to pay back, and if you ultimately can’t pay it back, you risk losing your home to foreclosure.
4. To Switch Mortgage Types
Refinancing also allows you to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, or vice versa. There are a couple of reasons why you may want to do this:
- Switching from ARM to fixed-rate: ARMs offer a relatively low introductory interest rate that can save you money on your monthly payments up front. But once that introductory period is over, your mortgage interest rate will likely rise and continue to readjust over the remaining loan term. You may decide to switch to a fixed-rate mortgage to avoid unpredictable rate changes and potentially higher mortgage payments.
- Switching from fixed-rate to ARM: On the other hand, if interest rates drop, an ARM’s low initial rates may be appealing. You might decide to switch from a fixed-rate mortgage to an ARM to lower your payments in the short term, especially if you plan to sell before the rate increases.
5. To Cancel Mortgage Insurance
Refinancing can be beneficial if it lets you cancel mortgage insurance, which is generally tacked on to your monthly mortgage payment. There are a few scenarios where mortgage insurance is necessary. For example:
- If you take out a conventional loan with less than 20% down, you must pay private mortgage insurance (PMI).
- If you take out a Federal Housing Administration (FHA) loan, you have to pay a mortgage insurance premium (MIP).
Homeowners with conventional loans can ask their lender to cancel PMI once they reach 20% equity in the home and have an 80% loan-to-value ratio (LTV). Refinancing to a lower interest rate may help you reach 20% equity – and remove PMI – ahead of schedule.
With an FHA loan, you can stop paying MIP after 11 years if you make at least a 10% down payment. A smaller down payment means you’ll have to pay MIP for the loan’s duration. However, you can get rid of FHA mortgage insurance by reaching the 20% equity threshold and refinancing to a conventional loan.
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When Not To Refinance Your Home
Refinancing can help you save money by lowering your interest rate, reducing your monthly payment or even allowing you to cancel your mortgage insurance. But it’s not always a smart financial move.
If you’re asking yourself if you should refinance your mortgage, here are some scenarios in which refinancing may not be worth the time, effort or money:
- You’re planning to sell soon. If you move before you reach the refinance break-even point (the time it takes for your savings to equal or outweigh the cost of refinancing), you won’t have enough time to recoup the cost of refinancing. To calculate your break-even point, divide the closing costs associated with the refinance by the monthly savings you’ll get with your new loan.
- You’re close to paying off your mortgage. If you’ve been paying your mortgage faithfully for a long time, most of your monthly payment likely goes toward your loan principal. If you refinance, you’ll start with a new amortization schedule, and you’ll pay more toward interest at the beginning. This may end up negating any savings you’d get from a refinance.
- Your credit has dropped. If your credit has dropped since you first took out a mortgage, it may be hard to qualify for a refinance or get a better interest rate. In this case, refinancing likely wouldn’t lead to savings.
- You don’t have enough equity. Most lenders require 20% equity to refinance. If you haven’t yet hit that benchmark, you may need to wait until you’ve paid more toward your loan’s principal.
- You want more cash for discretionary purchases. A cash-out refinance to consolidate debt or make necessary home repairs is one thing. But if you’re only tapping your home’s equity to spend on discretionary purchases – like new furniture or an expensive vacation – you may be taking on unnecessary financial risk.
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Factors To Consider Before Refinancing Your House
Even if you think refinancing is the right move for you, don’t rush into it. Instead, take time to consider these factors to make sure a refi is a smart financial move:
- Current mortgage rates: Interest rates play a big part in determining your monthly payment and how much you pay in interest over the life of a loan. If rates are low and you want to take advantage, compare lenders to find the most attractive rate and terms.
- Break-even point: Refinancing a mortgage typically involves closing costs that range from 2% – 6% of the total loan amount. If you move before any savings outweigh the cost of refinancing (the break-even point), a refi won’t be worth it.
- Refinance requirements: You must meet a lender’s requirements to refinance your mortgage, including a minimum LTV, debt-to-income ratio, credit score and down payment requirements. If you don’t meet these requirements, you may want to focus on making regular, on-time mortgage payments to boost your credit and build equity.
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The Bottom Line: When To Refinance Depends On Your Circumstances
If you’re trying to save money on housing costs, refinancing your mortgage can potentially lower both your interest rate and monthly payments. You might also consider a refinance if you need to tap your home’s equity for certain expenses.
However, before you start the process of refinancing, consider key factors such as current interest rates, the cost of refinancing, any plans to move and whether you meet lender requirements.
If you think you’re ready to refinance your home, use the Quicken Loans Mortgage Refinance Calculator to estimate your savings.
Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
