Is it a good time to refinance?

When interest rates take a dip, homeowners tend to get curious about refinancing. The logic seems obvious—if rates go down, you should pounce on the opportunity to renegotiate the terms of your loan, right? But as is often the case with financial decisions, it’s not as simple as that.

While market trends can indicate that it’s generally more favorable to refinance (emphasis on the “generally”), this shouldn’t be the sole determining factor in deciding to swap your current mortgage for a new one…so how do you know if it’s a good time to refinance? It comes down to why you’re refinancing in the first place and how long you’re planning to stay in your home.

What are the benefits of refinancing?

First things first: refinancing a mortgage is when you swap out your old loan for a new one. There are two main objectives that typically motivate homeowners to refinance: saving money and cashing in on equity. While there are a few circumstances where it’s normally advisable to refinance (if you can secure a lower interest rate, if you can reduce the length of your loan, or if you can swap an adjustable-rate mortgage for a fixed-rate mortgage, to name a few), you’ll want to make sure the savings outweigh the costs and fit with your personal financial priorities before moving forward. Let’s take a look at some popular reasons for refinancing and how to decide if it’s a good fit for you:

Refinancing to reduce your monthly mortgage cost

Refinancing for a lower interest rate can help you spend less on your mortgage every month—and reducing by even 1% can also have a big impact over the life of a 30-year loan. However, it only makes sense if you plan to stay in your home long enough to “break even”, or recoup the cost of refinancing with savings from your new loan terms. To calculate your exact break even timeline, you’ll need to crunch some numbers. (If math gives you a headache, we have a simple refinance calculator that’s easy to use.)

Just like with your original purchase mortgage, refinancing comes with some fees and closing costs. With Better Mortgage’s rate tool, you can see the total one-time costs for different rates and loan types. This amount will initially offset any savings you stand to gain from a lower interest rate, so it’s important to work with a lender that minimizes closing costs. For example, Better Mortgage doesn’t charge application fees, origination fees, or underwriting fees, and our loan officers never get paid commission.

Let’s say the cost of refinancing comes to $3,000 at closing and you lock in a new interest rate that saves you $72 per month. You’ll need to make 42 mortgage payments ($3,000 divided by $72) before you start actually saving money from your refinance. If you plan to be in the home for longer than 42 months (roughly 3.5 years), then it may be a good time to refinance!

Another thing to keep in mind: if you’re interested in refinancing, you don’t necessarily have to wait around for a market dip. Yes, interest rates are partially determined by the market, but you might also be able to qualify for a lower rate if you’ve paid off a good chunk of debt or improved your credit score since you bought your home.

Refinancing to get a different type of loan

Fixed-rate mortgages and adjustable-rate mortgages (ARMs) have different interest conditions. The basic gist is that a fixed-rate mortgage offers a locked interest rate for the life of your loan, whereas the interest rate on an ARM starts out low then fluctuates with the market over time. Refinancing gives you the opportunity to choose a mortgage that most aligns with your financial goals and hopefully saves you some money in the process.

If you have an ARM and are planning to stay in your home for more than a few years, it might make more sense to refinance with a fixed-rate mortgage. Knowing how much you’ll be paying in interest over the life of your loan will help you budget for consistent payments and protect you from unpredictable (potentially expensive) rate spikes. On the flipside, it might make sense to swap a fixed-rate mortgage for an ARM if you’re planning to move out of your home in a couple of years. ARMs offer low rates in the initial period of the loan, and refinancing could help you capitalize on those rates in the short term. Just make sure the timing works out—in this case, you would want to sell your home and pay off that mortgage before the rate increases to avoid costly interest payments down the line.

Refinancing to pay off your debt faster

When you got your initial mortgage, you may have chosen a longer loan term (say, 30 years) to secure lower monthly payments. However, that also means higher interest over the life of the mortgage. Refinancing gives you the opportunity to lock in a different mortgage term and potentially pay off your loan faster, which can significantly reduce the total amount you pay in interest. Should you do it? It depends on the remaining principal amount of your loan when you refinance and how much you can budget for your monthly payments.

If there’s a significant amount of principal balance remaining, changing the term of your loan from 30 years to 15 years could dramatically increase your monthly payments. If you’ve already paid down a good portion of your principal, refinancing with a shorter term could help you score a lower interest rate and pay off your mortgage debt faster—the best of both worlds. On the other hand, if reducing your monthly expenses is the goal, you might want to refinance to a longer term. While you’ll pay more interest on the loan over time, your monthly expenses will be more manageable. It might seem counterintuitive, but this could have a positive impact on your overall wealth if you prioritize cash flow or being able to invest that extra money every month in other areas of your life.

Refinancing to get rid of private mortgage insurance (PMI)

Private mortgage insurance (PMI) is a required monthly cost for most conventional loans. If you have less than 20% for your down payment when you close on your purchase mortgage, your lender will require you to pay PMI; this offsets some of their financial risk when funding loans to homeowners without as much upfront cash available. When you reach 20% equity in your home, you can request to cancel PMI. Most homeowners reach this equity benchmark by making consistent mortgage payments that chip away at the principal of their loan, but refinancing might provide a faster path to ditching PMI that saves money in the long run.

If your home has gained value since you bought it, you may already have a mortgage balance (80% or less) that exempts you from PMI. By refinancing based on the new appraised value of your home, you can avoid paying PMI on your new loan altogether. Again, this would only be worthwhile if the savings from the insurance payments cover the cost of the refinance itself. PMI costs on average between 0.5%–1.5% of your loan amount, but it can vary based on your debt-to-income ratio (DTI), credit score, and the size of your down payment. Since you can simply request PMI be removed when you reach 20% equity in your home, it might not be financially advantageous to refinance solely to get rid of private mortgage insurance.

Refinancing to tap into home equity

So far, we’ve covered traditional refinancing options that replace your original mortgage with a new one for the same amount—the terms are the only things that change. Cash-out refinancing replaces your original mortgage with a new one that has a higher loan amount and allows you to pocket or “cash-out” the difference. To do this, you need to have paid down your mortgage and gained some equity in your home. Leveraging your equity in this way can help fund other big expenses in your life, but it’s not without risk—ultimately, you’ll be signing up to pay back a mortgage for more than your home is worth.

Equity is the difference between your home’s value and the remaining balance on your loan. Let’s say your home is valued at $300,000 and the remaining balance on your mortgage is $200,000. That gives you $100,000 of equity in your home. You can refinance your mortgage for $250,000 and cash out the additional $50,000 for other expenses. As with any refinance, there are closing costs and fees to consider along with the variables of the new loan terms—ideally you’ll be able to score a lower interest rate in the process. The benefits of a cash-out refinance can be significant if you’re putting the money to good use, like paying off debts or reinvesting in your home with renovations. Just make sure you understand the implications of the new loan and how repayments on the new amount will impact your other financial goals.

Should you (yes, you) refinance?

When interest rates take a dip, it can be an indicator of opportunity. Plenty of homeowners might be tempted to jump on the bandwagon and snap up a lower interest rate or shorter loan term. But you have to consider your financial goals and your plans as a homeowner above all else. At the end of the day, the goal of refinancing is to save money, and you should only choose to refinance if you can guarantee that you’ll be able to do that based on your personal goals and your financial situation.

The best way to know exactly what kind of refinance you qualify for is to get pre-approved. See your personalized rates and terms in as little as 3 minutes with Better Mortgage.