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Should I Refinance My Mortgage and When?

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Mortgage payments are the most significant expense for most people, with the typical U.S. homeowner paying $1,944 per month toward their mortgage.[1] In certain cases, refinancing can help save you money or reduce the size of your monthly mortgage payments.

Some homeowners who refinance do so because interest rates are lower and they want to save money. While it’s true that interest rates are constantly changing and a lower rate may save you money, choosing to refinance your mortgage is about more than interest rates alone. 

Instead, refinancing should be a personal decision that’s based on your unique financial situation, financial goals and options for refinancing. 

Keep reading to learn about some common reasons why homeowners refinance, how to decide if you should refinance and when to refinance.

Why Should I Refinance My Mortgage?

There are different types of refinancing options, and each comes with its own benefits for homeowners. For example, a cash-out refinance would be a great choice if you want a lump sum of money to pay off debt with a higher interest rate, but it wouldn’t be a good fit if your priority is paying off your mortgage earlier. 

A common reason people refinance is to take advantage of lower interest rates. Though a small change in interest rates might seem insignificant, it can save you tens of thousands of dollars over the course of a 30-year loan. 

If you have a $300,000 mortgage on a 30-year loan, the difference between a 7% interest rate and a 6% interest rate amounts to $197 in monthly savings. After 30 years, this translates to $70,920 saved – all because of a 1% drop in your interest rate. 

Let’s explore some of the refi options available and why you might use them.

Change your loan term

You can use a refi to change your loan term. There are few reasons to refinance to a shorter or longer loan term, such as:

  • Taking advantage of lower monthly payments
  • Locking in a lower interest rate
  • Making fewer interest payments
  • Paying off your mortgage faster

Refinancing to a longer term

If you take out a 15-year mortgage but want a little breathing room, refinancing to a longer loan term – like a 30-year – can help reduce the size of your monthly payments. 

Since you’ll have twice as much time to pay off the loan, a longer loan term can lower your monthly payments. Longer loan terms can also make it easier for you to budget. However, you’ll end up paying more interest over the life of the loan, and it’ll take you 15 more years to pay off your home.

Refinancing to a shorter term

Say you have a 30-year loan, but you want to get the lowest possible interest rate, build equity faster and pay off your mortgage sooner. 

You can refinance from a 30-year term to a 15-year term, which can save you a significant amount of money – though your monthly payment obligations will likely increase.

Pay off your debts

Refinancing to pay off debt can be a helpful option for homeowners looking to consolidate debt and pay off high-interest loans. However, using a refi to pay off debt can cost you several thousand dollars in fees and often results in a longer mortgage term.

Unfortunately, many people who transfer their high-interest debt into a lower-interest mortgage end up racking up new debt. So if you go the route of refinancing to pay off debt, make sure you have a solid plan before applying for a refi and that you’re committed to permanently getting rid of bad debt.

There are two primary ways you can use a refi to pay off debt.

First, with a cash-out refi, you can use the money you get to pay off your debts all at once. Alternatively, you can take out a standard refi, which will lower your monthly payment and create monthly savings you can use to pay down debt.

Finance home improvement project or renovations

A cash-out refinance can provide a lump sum payment for funding home improvement projects and renovations. Whether you need to replace an aging roof or want to upgrade your kitchen, refinancing can help you pay for these projects. 

Refinancing usually comes with lower interest rates compared to other types of debt, such as credit cards and personal loans.

If you want to get the most out of your home improvement projects, check out these five renovations that can help you increase your home’s value.

Build your retirement savings

Another way to use a cash-out refi is to help boost retirement savings. Generally, the earlier you start saving, the more your money will grow. 

You can invest the money from your home equity in your retirement account, potentially earning returns that are greater than the interest you’ll pay on your mortgage.

Keep in mind that investing in your retirement account can have certain limitations, like when you can withdraw the money. There’s also the risk of losing money on your investments in the stock market.

Switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage

Some borrowers who refinance switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. The interest rate on an ARM typically changes once or twice per year after the introductory period ends. 

If interest rates increase, you may end up paying significantly more interest over the life of the loan compared to a fixed-rate mortgage.

Refinancing from an ARM to a fixed-rate loan can help you save money and make budgeting more predictable, since your monthly payment stays the same. 

Be aware that switching from an ARM to a fixed-rate mortgage isn’t always the best option. If interest rates drop after you refi to a fixed rate, you can’t change the rate. And as with all refis, you have to ensure the savings ultimately exceed the closing costs you’ll have to pay.

Switch from an FHA loan to conventional

Refinancing can help you switch from a Federal Housing Administration (FHA) loan to a different type of loan, like a conventional mortgage. Unlike other mortgages, FHA loans charge borrowers an upfront mortgage insurance premium (MIP) fee in addition to ongoing mortgage insurance premiums, which either last for 11 years or for the duration of the loan. All FHA loans, regardless of the size of the down payment, include an upfront fee of 1.75% of the loan amount.[2] 

If you have an FHA loan and reach a loan-to-value (LTV) ratio of less than 80%, refinancing to a conventional loan can eliminate your MIP payments. 

How To Decide If You Should Refinance

Before you make any changes to your home loan, think about your finances and consider the cost of refinancing, so you can determine whether it’s worthwhile to replace your existing mortgage.

Review your finances

If you want better terms on your next mortgage, take account of your finances and make sure you’re in a good position to qualify for the best possible refi.

When lenders review your application, they’ll look for a low debt-to-income (DTI) ratio, a good credit score and other documentation proving your creditworthiness. Giving a lender confidence that you’re willing and able to pay back your mortgage on time will go a long way in helping you earn approval.

Know the cost of refinancing

Just like the closing costs you have to pay on a new home loan, the costs of refinancing a mortgage can amount to thousands (or tens of thousands) of dollars. 

These costs depend on things like the type of mortgage, loan amount and the state the home is in. Typically, refinancing can cost you anywhere between 3% – 6% of the new loan amount.[3]

Common fees associated with refinancing include:

  • Home appraisal fees ($300 – $500)
  • Origination fees (up to 1.5% of the loan’s value)
  • Application fees (up to $500)
  • Title search and lender’s title insurance (varies by state, but often $1,000 – $2,000)
  • Attorney fees, recording fees, credit reporting, document preparation and other miscellaneous fees (up to $1,000)

Calculate the numbers

To know whether it’s worth it to refinance, break out your calculator and do the math.

Say your current mortgage payment is $1,800 per month. Your new mortgage payment, which has the same term length, has a lower rate and monthly payments of $1,600. So the refi will save you $2,400 per year, but it will also cost you $8,000 in fees. 

This means that after 3 years and 4 months, your refi will start saving you money.

If you’re refinancing to pay off your mortgage sooner, finance home improvement projects or save for retirement, make sure your refi is helping you achieve your long-term financial goals and that you can comfortably afford your new monthly payment. 

When Should I Refinance?

There’s no perfect time to refinance, but if interest rates drop or your credit score increases, you may be able to get more favorable terms. 

If you’re wondering how soon after closing you can refinance, there are no laws limiting when you can refinance. Nevertheless, many lenders have a waiting period of 6 months. 

If you’re considering a cash-out refi, you’ll also have to wait until you have at least 20% equity in your home, which can take more than 6 months if you made a smaller down payment when purchasing the home.

Ready, Set, Refi

Refinancing isn’t cheap. But under the right circumstances, it can help you save money, pay for home improvements, free you of bad debt or pay off your mortgage sooner. 

When you choose a mortgage refinance, first think about how it’ll impact your overall financial situation, weighing the pros, cons, costs and savings.

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The Short Version

  • There’s no perfect time to refinance, but if interest rates drop or your credit score increases, you may be able to get more favorable terms
  • Though a small change in interest rates might seem insignificant, it can save you tens of thousands of dollars over the course of a 30-year loan
  • Typically, refinancing can cost you anywhere between 3% – 6% of the new loan amount
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  1. National Association of Realtors. “Housing Affordability Conditions Fade as Mortgage Rates Push Monthly Rates Higher in June 2022.” Retrieved November 2022 from https://www.nar.realtor/blogs/economists-outlook/housing-affordability-conditions-fade-as-mortgage-rates-push-monthly-payments-higher-in-june-2022

  2. United States Department of Housing and Urban Development. “Appendix 1.0 – Mortgage Insurance Premiums.” Retrieved November 2022 from https://www.hud.gov/sites/documents/15-01MLATCH.PDF

  3. The Federal Reserve Board. “A Consumer’s Guide to Mortgage Refinancings.” Retrieved November 2022 from https://www.federalreserve.gov/pubs/refinancings/

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