As your financial situation changes, your mortgage should work for you, not the other way around. Refinancing allows you to replace your existing home loan with a new one that may offer better rates, lower payments, or updated terms.
But refinancing may come with additional costs and extensive paperwork, so understanding when it makes sense is key to ensuring the benefits outweigh the cost.
The Best Times to Refinance Your Mortgage
Refinancing makes the most sense when it puts substantial long-term savings back in your pocket. These circumstances include:
- Market rates have dropped: Because interest rates fluctuate, a drop in rates can be a strong signal to refinance. Securing a lower fixed rate (especially if you have years left on your mortgage) can lead to substantial long-term savings.
- Your credit has improved: Improving your credit may make refinancing more beneficial. Stronger credit can help you qualify for better terms, potentially lowering both your interest rate and monthly payment.
- You can afford higher monthly payments: If you’re earning more or have paid off other debts, refinancing to a higher monthly payment can help you shorten your loan term and become mortgage-free sooner.
When It’s Best Not to Refinance Your Mortgage
Refinancing can be beneficial, but it’s extremely situational. It’s often best not to refinance in situations like these:
- To extend the term of the loan: While refinancing at a lower rate can lower your payment, it doesn’t always mean long-term savings. Homeowners well into a 30-year mortgage may pay more interest overall by starting a new loan term and extending payments for additional years.
- To consolidate debt: Debt consolidation through refinancing can seem appealing because mortgage rates are typically lower than credit card rates. However, turning unsecured debt into debt secured by your home means you could risk losing your house if you fall behind on payments.
- To save money for a new home: Because refinancing can cost 2–4% of your loan, it may take several years to see real savings. If you’re planning to sell your home before then, refinancing likely won’t be cost-effective.
- To splurge on an expensive purchase: A cash-out refinance replaces your mortgage with a larger loan, giving you the difference in cash. While some use it for big purchases, it can be costly—closing fees can be thousands, and loans over 80% of your home’s value may require PMI. Experts, like mortgage planning specialist Elizabeth Rose, caution against using home equity for anything that doesn’t improve your finances or add security.
- To take cash out for investing: Refinancing your mortgage to free up cash for investing is usually not wise. It’s easy to spend the extra money, and it takes discipline to invest consistently. In many cases, paying down your mortgage offers a safer long-term return than investing in riskier stocks.
- To take advantage of a no-cost refinance: There’s no such thing as a truly “no-cost” refinance. Lenders may waive upfront fees, but those costs are added to your loan through higher interest or rolled into the mortgage, meaning you’ll pay interest on them over the life of the loan.
Determining the Value of Refinancing
Ultimately, the value of refinancing is based on comparing savings to costs. Some of the factors you’ll want to look at include the following:
- Lower interest: If the amount of interest saved over the life of the loan would be more than the loan’s closing fees, then it’s typically best to refinance. Essentially, the amount saved depends on four factors: drops in the market rates, your credit score, your lender, and the amount of time left on your loan.
- Increased ability to pay: If you can handle a higher monthly payment and pay off your loan early, you could save on interest. How much depends on current rates, your credit score, your lender, and the remaining months versus the term of the new loan.
- Paying off your debt: Some benefits of refinancing are less tangible. Paying off your mortgage sooner can reduce your monthly burden, free up funds for other expenses, and increase overall financial freedom. If refinancing helps you achieve this, it can be well worth it.
- Balancing out associated fees: When deciding whether to refinance, factor in closing costs, which usually total 2–5% of your loan. Your new mortgage should save at least that amount to make refinancing worthwhile.
Is Refinancing Right for You?
Figuring out if refinancing makes sense is easier than it seems. Use a mortgage calculator to explore your options and see how refinancing could help you save, reduce your payments, or reach your financial goals sooner.