When is refinancing a mortgage worth it?

Refinancing your mortgage can be a smart financial move, potentially saving you money on your monthly mortgage payment or on total interest over the life of your home loan.

Before you apply, you’ll want to think carefully about when to refinance your mortgage. You’ll also want to decide if refinancing makes sense financially by weighing any money you’ll save against the cost of refinancing the loan.

We’ll review some common scenarios to think through.

• When does it make sense to refinance?
  1. Mortgage rates have gone down
  2. Your credit has improved
  3. You want a shorter loan term
  4. Your home value has increased
  5. You want to convert from an adjustable rate to fixed
• When does refinancing a mortgage not make sense?
  1. You have a prepayment penalty
  2. You’re moving soon
  3. You have an existing home equity loan
  4. Your refinancing fees are too expensive
  5. You’re almost done paying off your mortgage

When does it make sense to refinance?

In general, mortgage refinancing will likely make sense when it makes sense for your finances. But part of that depends on your financial goals. For instance, do you want a lower monthly payment? Are you trying to save in total interest paid? Do you need to extract cash from your home with equity you’ve built? You can use Credit Karma’s loan amortization calculator to explore how different loan terms affect your payments and the amount you’ll owe in interest.

Here are five situations to think about before you refinance.

1. Mortgage rates have gone down

Mortgage rates for homeowners can fluctuate since they’re affected by a variety of factors, including U.S. Federal Reserve monetary policy, market movements, inflation, the economy and global factors.

If mortgage rates fall, you may be able to save by securing a lower interest rate than you have on your existing loan.

So how much should mortgage rates fall before you consider whether refinancing is worth it? The traditional rule of thumb says to refinance if your rate is 1% to 2% below your current rate.

Make sure to factor in your current loan term when considering refinance though. For instance, if you’re four years into a 30-year mortgage and refinance to a new 30-year term, it will have taken you 34 years total to pay off your home in the end. Plus, you’ll likely pay more interest over the extended term than if you had chosen a shorter term.

No matter what rates are doing, you’ll want to check that the math works out in your favor. “Make sure to calculate your break-even point and how the overall costs — including total interest — of your current mortgage and your new mortgage would compare,” says Andy Taylor, general manager for Home/Mortgage at Credit Karma.

2. Your credit has improved

Your credit is a significant factor in determining your mortgage rate. Generally speaking, the better your credit is, the lower the interest rate you’ll receive.

Let’s look at an example based on recent interest rates. If you have a 30-year fixed-rate mortgage of $150,000 and your FICO® credit score is within the 660 to 679 range, the myFICO Loan Savings Calculator estimates you could pay 3.375% APR (based on interest rates as of Oct. 10, 2021).

With this interest rate, your monthly payment would be $663 and your total interest paid across 30 years would amount to $88,732.

In comparison, if your credit score was in the 700 to 759 range, the calculator estimates your monthly payment would drop to $631 (based on rates as of Oct. 10, 2021). And over the life of the loan, you could save more than $11,500 in interest.

3. You want a shorter loan term

If you’re keen to pay off debt, you may want to refinance your mortgage to a shorter loan term. You could add to your savings if you can secure a lower interest rate and shorten your term. A shorter loan term means you’ll pay less in total interest.

But one word of warning: You’ll probably be increasing your monthly payment in exchange, so make sure it fits into your budget. You don’t want to risk defaulting on your loan.

4. Your home value has increased

If the value of your home has gone up, you might also get some benefit from refinancing, especially if you have other high-interest debt to pay off or another financial goal.

A cash-out refinance lets you take out a new mortgage that’s larger than what you previously owed on your original mortgage, and you receive the difference in cash. A cash-out refi is an alternative to a home equity loan.

You also might consider a cash-out refi for home improvements or to pay for a child’s education.

But you’ll want to make sure you don’t end up paying more in mortgage interest than the interest you would pay on any debt you’re using the cash to pay off.

5. You want to convert from an adjustable rate to fixed

If mortgage rates are increasing and you currently have an ARM — or adjustable rate-mortgage — you may want to consider refinancing and converting to a fixed-rate mortgage. That’s because with an ARM, your rate may increase beyond what you’d pay with a fixed-rate mortgage. If you’re concerned over future interest rate hikes, a fixed-rate mortgage could provide some peace of mind.

When does refinancing a mortgage not make sense?

It’s also possible that now might not be the best time to refinance your mortgage. Here are five situations where it might not be worth it for you to refinance your home.

1. You have a prepayment penalty

If your existing mortgage has a prepayment penalty, consider if you’ll save enough to make paying the penalty fee worth it. And ask your lender if it’s willing to waive the penalty if you refinance your mortgage with it.

2. You’re moving soon

Do you already have your eye on a new home? Calculate your break-even point to make sure you won’t lose money once you factor in the costs of refinancing.

3. You have an existing home equity loan

If you have a home equity loan or line of credit (also known as a HELOC), you may have to ask that lender’s permission to refinance your loan. If it doesn’t agree, you might have to pay this account off before you can refinance.

4. Your refinancing fees are too expensive

A mortgage refinance can be expensive. Here are some typical fees you may have to pay.

• A mortgage application fee (which might range from $250 to $500)
• Origination fee (about 1% of your loan value)
• Appraisal fee ($300 to $600)

Make sure you know what costs to expect and whether you can afford them. If you’re unable to pay the fees at this time, you may need to wait before refinancing.

5. You’re almost done paying off your mortgage

In the early years of your mortgage term, your payments primarily go toward paying off interest. In the later years, you begin to pay off more principal than interest, meaning you start to build up equity — the amount of your home that you actually own.

Once you refinance, it’s like you’re starting over. Say you’ve been paying off your old mortgage for 10 years, and you have 20 years to go. If you refinance into a new 30-year mortgage, you’re now starting at 30 years again.

Before you decide to refinance, calculate your break-even point and how the overall costs — including total interest — of your current mortgage and your new loan would compare. Take note that refinancing usually makes more sense earlier into your mortgage term.

Next steps

Refinancing, just like applying for a mortgage, can take significant time and effort. You may need to obtain additional paperwork and spend time understanding your options, so consider whether the savings you could receive make up for this extra effort before starting the process.

Additionally, since your credit can affect your interest rate, you should know what kind of shape it’s in. If it’s not in great standing, you may want to take steps to improve your credit before you refinance. And if you end up deciding that it’s worth it to refinance your mortgage, you can start by comparing today’s mortgage rates on Credit Karma.

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