Should I Refinance My Mortgage?
Refinancing your mortgage can help you save money and manage your monthly payments more easily - if you're careful to understand when the transaction works in your favor.
There are many reasons to refinance. Whether refinancing makes sense for you depends on the goal you're trying to achieve.
A refinance calculator can help you crunch the numbers. It's up to you to know whether those results work to your benefit or not.
But it's often not a straightforward, yes-or-no answer. This guide is designed to walk you through using the calculator and helping you recognize results that indicate you should refinance.
A refinance calculator gives you a side-by-side comparison between your current mortgage and a refinance offer from a lender.
Using a refinance calculator is pretty simple. It's basically a fill-in-the-blanks process.
What to enter into the calculator:
- Origination date (month/year) of your current mortgage
- Original loan amount or your current mortgage
- Original loan term (in years) of your current mortgage
- Interest rate of your current mortgage
- The amount you would refinance
- Loan term (in years) of the refinance offer
- Interest rate for the refinance offer
- Closing costs of the refinance offer
Refinance calculator results
Once you enter that information, the loan calculator shows four key types of results:
- Monthly payment comparison
This is a comparison between your current monthly payment and what those payments would be if you refinance. (Your immediate concern should be whether you can afford the new month-to-month payments, but lower payments do not necessarily mean your long-term costs will be lower.)
- Closing costs
Starting a new loan costs money, so you need to compare [compensate for] those costs with the savings or other benefits you would get from refinancing.
- Breakeven point
Refinancing often involves a trade-off between paying up-front closing costs and saving money on your monthly payment in the long run. The breakeven point tells you how long it would take for those monthly savings to recoup your closing costs.
- Total payments
Smaller monthly payments do not necessarily save you money in the long run. In fact, they could cost you more if they mean it takes you longer to pay off your mortgage.
Comparing the total remaining payments on your current loan with the total costs of refinancing, including closing costs and all future payments, shows what the long-term financial benefit would be.
All those results are important, but which ones matter most depends on why you are refinancing.
To show how these results fit together to guide your refinance decision, it's helpful to look at the major reasons people refinance and see what is important to know in each circumstance.
Here are several situations where refinancing might be a viable option that you'd want to think through:
- Interest rates have dropped
- You are within 20 years of paying off a 30-year mortgage
- You can afford higher monthly payments
- You are having trouble meeting your monthly mortgage payments
- Your credit score has improved
- You have student loan debt, credit card debt or other debt you want to retire
- You are considering a home renovation project
The following section explains what you should look for from the results of a refinance calculator to decide whether it's worth it to refinance in each of the above cases.
Is It Worth It to Refinance?
A mortgage calculator can help you see whether the opportunity to refinance can help you meet your goals. Those goals depend on your reasons for refinancing, as explained in the examples below.
If interest rates have dropped...
Mortgage rates go up and down over time. If they have dropped since you first took out your mortgage, you may have an opportunity to save money by refinancing.
Desired Result: Lower payments, potential to reduce total interest expense.
Lowering your interest rate should lower the interest component of your monthly payments, potentially lowering your monthly payments and reducing the total interest expense you pay over the life of your mortgage.
Must Meet This Condition: New mortgage has roughly the same term.
However, refinancing at a lower interest rate is most likely to accomplish both these goals only if your new mortgage is of roughly the same length as the remainder of your existing mortgage.
Here's What To Know:
If you shorten the remaining mortgage term, it could result in higher monthly payments. If you lengthen the term of the mortgage, it could raise your total interest expense over the life of the mortgage.
Note that in most cases, if you refinance your current 30-year mortgage with a new 30-year mortgage, it effectively lengthens the term of your mortgage. That's because presumably you've already paid down some of that mortgage so it would have less than 30 years to go.
In that case, refinancing to a fresh 30-year mortgage effectively restarts the clock. This means more years of paying interest, which could raise your total interest expense.
Watch Out For This:
Another thing to watch out for when refinancing to lower your interest rate is the closing costs of the new loan. You have to make sure your interest savings are more than enough to cover those closing costs.
How To Evaluate:
To make sure refinancing is worth it, compare your total interest savings with the closing costs when using the refinance calculator.
You should also consider the break-even point. This is the time it will take for your interest savings to recoup your closing costs. The longer that takes, the less attractive refinancing is.
Ideally, you should see three things to fully benefit from refinancing at lower interest rates:
- Total interest savings which exceed your closing costs.
- Monthly payments that are lower than your current payments.
- A break-even point within a few years.
If you are within 20 years of paying off a 30-year mortgage...
Desired Result: Potential to reduce total interest expense even if refinance rate isn't lower.
If you've been paying your mortgage down for ten years or more, you might be able to lower your interest rate even if mortgage rates generally haven't fallen.
That's because shorter-term mortgages usually have lower rates than longer-term mortgages.
Must Meet This Condition: New mortgage must be a shorter term than original loan.
So, if you are ten years into a 30-year mortgage, you might benefit by refinancing to a 20-year mortgage. If you are 15 years into paying off your 30-year mortgage, you might consider refinancing to a 15-year mortgage.
How To Evaluate:
To see if this works in your favor, evaluate the results of a refinance calculator according to the guidelines described in the above section on refinancing to lower your interest rate.
If you can afford higher monthly payments...
This situation illustrates how different approaches to refinancing can yield a desirable result, even in ways you might not expect.
Desired Result: Potential to reduce total interest expense by making larger payments.
Perhaps you have a new job or got a raise and your income has gone up.
If your financial position has improved since you first took out your mortgage, you might benefit in the long run by shortening the term of your mortgage.
This is likely to raise your monthly payments, but could have two long-term benefits:
- Paying your mortgage off over a shorter period of time should mean fewer interest payments.
- Also, refinancing to a shorter mortgage may allow you to get a lower interest rate.
Must Meet This Condition: New mortgage must be a shorter term than the original loan, with the same interest or less.
Clearly, refinancing is not the only way to reduce your total interest expense if you can afford higher monthly payments. You could simply pay down the principal and effectively accomplish the same thing, without the additional expense of closing costs. If your current mortgage doesn't allow that, though, you may need to refinance in order to reach the larger goal.
How To Evaluate:
When considering this approach, look for the following in your refinance calculator results:
- Total interest savings over the life of the mortgage that exceed closing costs on the new loan.
- A break-even period of only a few years before you recoup closing costs.
- Monthly payments that you can comfortably fit into your budget.
If you are having trouble meeting your monthly mortgage payments...
If trouble meeting your monthly mortgage payments is putting your house at risk, then you should see how refinancing might help.
Desired Result: Lower payments.
The ideal situation is to lower those payments by refinancing at a lower interest rate. However, this depends on market conditions so this option is not always available.
Still, you might also refinance to lengthen your remaining repayment period. Stretching those payments over a longer time should lower your monthly payments.
Here's What To Know:
The rub is that this is also likely to increase your total interest expense over the life of the mortgage. However, that may be a price you are willing to pay to avoid losing your home.
How To Evaluate:
If lowering monthly payments is your goal, look for the following results from your refinancing calculations:
- Confirm that your new monthly payments would be readily affordable.
- Look at the increase in total interest expense plus the closing costs to see how much this strategy will cost you in the long run.
If your credit score has improved...
This is a fairly common scenario. Often when people first buy a house, they are early in their careers and have established only a limited credit history.
Later on, a higher income and stronger credit history might qualify you for better loan terms.
This may allow you to lower your interest rate even if mortgage rates generally haven't dropped. To check if this is worthwhile, see the guidelines in the above section on refinancing to lower your interest rate.
If you have student loan debt, credit card debt or other debt you want to retire...
Mortgage debt is one of cheapest ways to borrow money. Thus, if you have other forms of debt and have built up some equity in your home, a cash-out refinance might make those other debts more affordable.
Desired Result: Reduce overall interest expense on all debt.
The way this works is that you refinance to a mortgage in a greater amount than the remainder of what you owe on your current loan. The difference is made available to you in cash and can be used to pay off those other debts.
How To Evaluate:
To see if this is worthwhile, focus on the following results from your refinance calculator:
- Obtain the total cost over the life of the new loan, including closing costs. Now compare this to what it would take to pay off your current mortgage plus your other debts.
- Monthly payments. Shifting more debt into your mortgage puts your house on the line, so you should be very sure you would be able to meet the payment obligations of the new loan.
If you are considering a home renovation project...
Desired Result: Finance remodeling at a lower interest rate.
If you have equity in your home, a home equity loan or a HELOC can be a cost-effective way to finance remodeling projects. However, cash-out refinancing may be even cheaper.
What To Know:
Refinancing to a larger mortgage and using some of the cash for your remodeling project may be cheaper than a home equity loan or HELOC because it is a primary mortgage. These generally offer lower rates than secondary mortgages.
This approach is especially attractive if you can refinance at a lower rate than your existing mortgage.
How To Evaluate:
To evaluate this option, you should:
- Calculate the total cost of a cash-out refinance over the life of the loan, including closing costs.
- Compare this to what it would cost to pay off both your existing mortgage and a home equity loan or HELOC for your remodeling project (including the closing costs on that new borrowing).
As the above examples show, refinancing can be applied to a number of situations. Experiment with a refinance calculator to make sure it would accomplish what you intend it to do.
Refinancing as Part of a Long-Term Plan
Mortgages are typically long-term debt obligations, so refinancing should be part of a long-range financial plan.
A financial advisor may be able to help you create that kind of long-range plan. That plan can help put your refinancing opportunity in context and see whether refinancing will help you meet future financial goals or could possibly interfere with them.
After all, your house may always be your single most valuable possession. It makes sense for the financing of that possession to be a centerpiece of your long-term financial plan.