Refinancing Your Mortgage: When Does It Make Sense?
How refinancing works, the break-even calculation, rate-and-term vs. cash-out refinances, costs, and when refinancing isn't worth it.
Refinancing replaces your current mortgage with a new one. People refinance to lower their rate or payment, shorten their loan term, switch from an adjustable to a fixed rate, remove mortgage insurance, or tap home equity. It isn't free, so it's worth running the numbers.
Types of refinances
- Rate-and-term: change the interest rate and/or term without taking cash out.
- Cash-out: borrow more than you owe and receive the difference in cash, usually at a somewhat higher rate. Many conventional cash-out loans are limited to 80% of the home's value.
- Streamline: FHA and VA offer simplified refinances for existing FHA and VA borrowers, often with reduced documentation.
Calculate your break-even point
Divide total closing costs by your monthly savings. If refinancing costs $6,000 and saves $200 per month, you break even after 30 months. If you plan to move or refinance again before then, it probably isn't worth it.
Watch the total interest, not just the payment
Restarting a 30-year clock can lower your payment while increasing total interest paid. If you're 8 years into a 30-year loan, consider a 20-year or 15-year term, or keep making your old payment amount on the new loan.
When refinancing may make sense
- You can lower your rate meaningfully and will stay past the break-even point.
- You want to escape an ARM before it adjusts.
- Your home value has risen enough to remove PMI or FHA mortgage insurance.
- You need to remove a co-borrower after a divorce.
When to be cautious
- Using cash-out to fund vacations or consumer spending puts your home at risk.
- Your credit has declined, which may wipe out rate savings.
- Rates are higher than your current rate. Many owners who locked low rates in 2020 and 2021 have little reason to refinance at today's higher rates; a home equity loan or line of credit may be a better way to tap equity.
The process
Refinancing looks a lot like the original mortgage: shop lenders, compare Loan Estimates, lock a rate, document income and assets, get an appraisal (unless waived), and close. For a refinance of your primary residence, federal law generally gives you a three-business-day right to cancel after signing.
This article is for general educational purposes and is not financial, legal, or tax advice. See our disclaimer.