Mortgage refinancing can be a good option if you want to save on your monthly mortgage payments or take advantage of the equity you gain in your home. But there are several factors you need to consider before proceeding with a refi. The main consideration is whether it makes financial sense.
To answer this question, use Money’s refinancing calculator to determine if refinancing is right for you.
How Money’s refinancing calculator works
Our mortgage refinance calculator can estimate how much you could save by refinancing. You will need to provide several pieces of information to the calculator, including details about your current mortgage, new loan amount, loan type, new interest rate, and credit rating. After entering all the required data, click the Calculate button to get the estimated payments of the new loan.
If you decide that refinancing is the right choice, it’s time to apply for a loan. Before you start looking for a lender, we recommend reviewing our research on the best mortgage lenders of 2024 to find the best rates for your location, credit score, loan amount and type.
What is mortgage refinancing?
Mortgage refinancing is when you take out another mortgage loan to pay off your existing mortgage balance. Ideally, this new loan will have a new term, a lower total interest rate, or both, resulting in significant long-term savings.
How does refinancing work?
Refinancing is an option for people who want to pay off their mortgage faster (by changing the term of the loan), lower their current monthly payment, or tap into the equity in their home for cash.
Home value is calculated by subtracting what you still owe on your mortgage from the current market value of your home. You can also divide your net worth by the value of your home to calculate your home’s equity percentage.
You will need to go through the application and eligibility process to refinance a home loan, just like when you took out your original mortgage. After loan approval, you will pay off the balance of your existing loan and continue with monthly payments on your new mortgage for the life of the term.
How much does it cost to refinance?
According to the Consumer Financial Protection Bureau (CFPB), the average closing costs for a mortgage refinance are around $6,000. But keep in mind that closing costs vary depending on the loan amount and the state in which the property is located.
Here are the standard costs included in the refinance loan closing disclosure:
- Evaluation fee: A professional appraiser examines the property and estimates its market value
- Legal fees: An attorney prepares documents and contracts: Not all states require the services of an attorney
- Escrow fee: A fee paid to the real estate agent or closing agent responsible for closing the loan
- Insurance costs: Homeowners insurance must be valid
- Points: Also known as discount points, they are used during closing to lower the interest rate of the loan: each point costs 1% of the loan amount and its purchase is optional
- Subscription fee: It covers the cost of evaluating your loan application
- Title insurance fee: Protects you from third-party claims against the property that was not listed in the initial title search
- Tax Service Fee: A fee for making sure borrowers pay required property taxes
When should you refinance your mortgage?
Refinancing your current home isn’t always a good idea, but it can be a wise financial move under the right conditions.
Refinancing a mortgage makes sense if you can achieve one of the following:
Lower interest rates
Locking in a new interest rate can result in:
- A lower monthly payment
- Pay less debt in interest over the life of your mortgage
To qualify for the lowest possible refinance rates, you will generally need to have a credit score of at least 740.
Shorter loan term
Spread your loan balance over a shorter loan term:
- Help you pay off your mortgage faster
- Lower interest payments over the life of the loan
Annual percentage rates are also generally lower for 15-year loans than for 30-year loans. However, the monthly payments are much higher. This option is best for those who have few long-term financial obligations and can afford the monthly mortgage payment.
Get the money you need now
For cash-out refinancing loans:
- Most banks will require you to keep at least 20% of your equity in the house
- High credit score requirements
Interest rates on cash-out refinance loans also tend to be higher. Most borrowers opt for this type of refinancing to cover home improvement expenses or to consolidate credit card debt or other higher-interest loans.
Get out of paying mortgage insurance
On conventional loans, private mortgage insurance (PMI) should automatically be canceled once you reach 80% of your home’s equity. However, with an FHA loan, you are required to pay mortgage insurance premiums (MIPs) over the life of the loan.
If you have enough equity and can qualify, refinancing into a conventional loan may be worthwhile. The FHA mortgage insurance premium ranges from 0.45% to 1.05% of the loan amount each year.
Changing from a fixed rate mortgage to an adjustable rate mortgage
Adjustable rate mortgages have a fixed interest rate for a set number of years, after which the rate becomes variable and changes based on market conditions. This variability means that you will periodically receive a new interest rate on the loan.
With a fixed-rate loan, your interest rate and monthly mortgage payments will remain the same for the life of the loan (that is, until you sell it, refinance it, or finish paying it off). Because of this predictability, fixed-rate mortgages are the best option for most borrowers, especially when rates are low and if they plan to stay in their home for an extended period.
When is refinancing your mortgage a bad idea?
Refinancing your current loan may not make sense in every scenario. If the cost of the new loan exceeds what you would save by refinancing, if your financial situation is uncertain, or if your credit score has taken a dip, refinancing may not be the smartest choice.
Other reasons why refinancing may not be the best option include:
If you are planning to move soon
If you plan to sell in the next few years, the monthly savings you get from refinancing cannot exceed the total cost of refinancing your loan.
If you plan to sell in the next few years, the monthly savings from refinancing cannot exceed the total cost of refinancing your loan.
To find out the break-even point of your new loan, add up your closing costs, which can include appraisal fees, title and credit report fees, and origination fees (between 2% and 6% of the loan amount ) and divide it by the amount you would save each month with the new payment.
According to the CFPB, average closing costs on a mortgage refinance are approximately $6,000. If you plan to stay in your home for less time than it takes to recoup what you would spend on closing costs, refinancing may not be a good deal.
If your credit score has decreased
When you apply for a refinance loan, lenders determine your creditworthiness in part by examining your credit score. The higher your credit score, the better your chances of getting a low rate.
If your credit score is lower than when you purchased the home, you may not qualify for a lower rate. If your score is low, you may want to work on improving your credit before refinancing.
How do I qualify for a mortgage refinance?
When you apply for a new mortgage or refinance loan, three main factors will affect your rates:
- Debt-to-income ratio
- Credit score
- Loan-to-value ratio
While credit score requirements vary by lender and loan type, a higher score will always mean a better rate. If you think your credit needs improving, there are ways to improve your score, such as checking your report for errors and fixing them.
Check out all three free copies of your annual credit reports from annualcreditreport.com.
Ultimately, the best way to improve your score is to develop good long-term credit habits, such as paying bills on time and keeping your credit utilization rate in check. Being patient is important because improving your credit score will take time.