When is refinancing a mortgage worth it?

Young couple leaning against a white backdrop with a laptop while discussing whether they should refinance their mortgageImage: Young couple leaning against a white backdrop with a laptop while discussing whether they should refinance their mortgage

In a Nutshell

There can be many options to consider when deciding if it’s worth refinancing your mortgage. Mortgage rate trends, your credit scores, home value, and even how soon you’re planning to move are all important elements to consider before making the decision to refinance.
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Should you refinance your mortgage?

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?

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.


How do you calculate your break-even point?

Figure out how long it may take for your refinance to pay for itself. To do this, divide your mortgage closing costs by the monthly savings your new mortgage will get you. If you’re paying $5,000 in closing costs but you’ll save $200 per month as a result of refinancing, it will take you 25 months to break even.

If you plan on staying in your home past the break-even point, it could make sense to refinance.

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 6.593% APR (based on interest rates as of April 3, 2023).

With this interest rate, your monthly payment would be $957 and your total interest paid across 30 years would amount to $194,626.

In comparison, if your credit score was in the 700 to 759 range, the calculator estimates your monthly payment would drop to $919 (based on rates as of April 3, 2023). And over the life of the loan, you could save more than $13,823 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.

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.

Types of mortgage refinancing

There are a number of ways to refinance your mortgage, and the one you choose should depend on your loan type and financial goals.

Here are six different options to consider.

  • Conventional loan refinance — When you refinance a conventional loan, you pay off your existing conventional loan and replace it with a new loan. Most people do this to take advantage of lower interest rates or to switch to a new loan type. A conventional loan means your mortgage isn’t part of a government program.
  • Cash-out refinance — A cash-out refinance allows you to tap into the equity in your home. You’ll take out a new loan for more than you owe on your mortgage and receive the difference in cash. Some people do this to pay down debt or finance a home improvement project.
  • FHA Streamline RefinanceA streamline refinance allows you to refinance your current FHA loan with minimal credit and underwriting requirements. To qualify, you must have an FHA loan that’s in good standing. And the refinance must benefit you somehow — for instance, you could receive a lower interest rate or a new loan type.
  • VA interest rate reduction refinance loanAn IRRRL is a type of mortgage refinance available to borrowers with VA loans who want to lower their monthly payments. You may qualify if you have an existing VA loan and the mortgage you’re refinancing is for your primary residence.
  • FHA cash-out refinanceAn FHA cash-out refinance allows you to access the equity you’ve built up in your FHA loan. To qualify, you must meet certain credit and debt-to-income ratio requirements.
  • VA cash-out refinanceA VA cash-out refinance allows you to access the equity in your current loan. One of the perks of a VA cash-out refinance is that you can refinance a non-VA loan into a VA loan.

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.

Estimate your closing costs

Use our closing costs calculator to get a better idea of how much your closing costs could be when buying a home.

FAQs about mortgage refinancing

When is it worth it to refinance?

It makes the most sense to refinance if it will benefit you and help you meet your financial goals. For instance, refinancing may be worth it if interest rates have dropped, your credit has improved or you want to switch to a shorter loan term.

Is there any downside to refinancing your mortgage?

Refinancing does come with trade-offs — for instance, you’ll have to pay fees and closing costs to refinance your mortgage. And if you’re planning to move in the future, you may end up losing money by refinancing.

How do you know if it is a good idea to refinance?

Refinancing could be beneficial for you if it helps you financially — it may you save money by lowering your interest rate or switching from an adjustable-rate mortgage to a fixed-rate mortgage.

What are the negative effects of refinancing?

One of the downsides of refinancing is that you may end up spending more than you saved if you move before reaching your break-even point. And when you do a cash-out refinance, you could end up with a higher monthly payment depending on your loan terms.

Does refinancing hurt your credit?

Refinancing may temporarily lower your credit score since your lender will do a hard pull on your credit reports. But the impact should be minimal in the long run.

About the author: Jamie Johnson is a Kansas City-based freelance writer who specializes in finance and business. She covers a variety of personal finance topics, including building credit, credit cards, personal loans and student loans… Read more.