When Should You Refinance Your Mortgage?

Are you wondering whether it’s time to refinance your home? It’s a question I help homeowners answer quite often. Ultimately, it comes down to personal circumstances, number-crunching, and one overarching question: Why are you looking to refinance?

Here are the various factors that I consider when helping someone decide whether to refinance. As you read, think about how you’d respond to these questions. Remember that certain answers influence how you respond to other questions!

CAN YOU GET A LOWER RATE?

Depending on when you took out your mortgage, you might be able to save money on interest. Compare the interest rate on your mortgage to the current rates. If you can get a lower rate, it’s worth talking to a mortgage expert to see what savings you could get by refinancing.

WHAT ARE THE CLOSING COSTS?

Unfortunately, a lower interest rate doesn’t always save you money. Just like your initial mortgage, you’ll have closing costs to create this new loan. In essence, you’ll be paying closing costs again on what’s left of your mortgage. Whether you roll these into your loan or pay them out of pocket, these expenses add up and may (or may not) offset the money you’d save on interest.

How much will you end up paying? A good starting estimate for closing costs is 2% to 2.5% of your loan amount. This figure could be higher based on a couple of factors: the loan-to-value ratio (how much you’re borrowing compared to the value of your home) and your credit score.

DO YOU WANT LOWER PAYMENTS OR TO PAY OFF YOUR MORTGAGE?

Refinancing gives you an opportunity to change the length of your mortgage. The question is, do you want to shorten your terms or extend them?

The decision to refinance with shorter terms depends on the monthly payments you can afford, when you plan to retire, and/or when you may sell your home. By going from, say, a 30-year to a 20-year mortgage, you pay more each month and build equity in your home faster.

(Note: You can also accomplish this by paying extra principal each month. This is where other factors come into play with your decision.)

On the flip side, extending your mortgage lowers your payments. This might be necessary if you lose a source of income, have an unexpected medical bill, or simply need a bit more breathing room in your budget. Because it will take longer to pay your mortgage, the trade-off is that you may pay more in interest over the life of the loan.

ARE YOU LOOKING TO GET CASH?

Are you ready to remodel your bathroom or kitchen? Home improvement projects require preparation, including how you’ll cover the costs of renovations. One way to get the necessary funds is a cash-out refinance.

In this situation, you refinance for a larger mortgage and get the difference back in cash. If you have $175,000 left to pay on your mortgage, you could refinance for a $200,000 mortgage and get back $25,000 to put towards home improvements.

Your answers to other questions—is there a lower rate, and what are your closing costs?—will determine if this approach makes financial sense, or if there’s another way to finance the kitchen or bathroom of your dreams.

ARE YOU CONSOLIDATING DEBT?

Another way to use a cash-out refinance is to consolidate debt. You’ll want to ask yourself a few questions and look closely at the numbers.

What kind of debt is it? What is the interest rate on that debt? Can you recoup your closing costs and still pay off those other debts? Is it simpler to just have the one mortgage bill to pay each month?

Otherwise, it may be worth going with a home equity loan or line of credit.

HOW LONG WILL YOU STAY IN YOUR HOUSE?

Your timeline in your house can help inform whether you should refinance.

If you plan to stay there for another 10 to 15 years, you could refinance to extend your terms. You can use your equity as a financial tool to lower your payments and put more of your budget towards other items.

If you are close to retirement and thinking of selling soon, refinancing probably doesn’t make sense. You’re better off avoiding the closing costs.

SHOULD YOU APPLY FOR REFINANCING?

Before you submit your loan application, get in touch with a mortgage expert. They can help you determine if there’s another way to get the loan you need at a lesser cost.

When it comes to refinancing, there are a lot of moving pieces to see if the math makes sense: interest rates, closing costs, mortgage terms, other debt, and your timeline and goals. Someone who goes through the process regularly can help translate your answers to these questions and identify the best financial option for you.

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About Tammy Farnham

With over 26 years of credit union experience, Tammy Farnham is a mortgage originator who serves the mortgage needs of Vermont families in Northeastern and Central Vermont, including Essex, Caledonia, Orange, Orleans and Washington Counties. Tammy enjoys helping Vermonters with their financial needs and assisting borrowers with their mortgage needs. Tammy grew up in Plainfield, where she currently lives with her husband and two grown children. She spends her free time helping with her family business, Farnham Farm Maple Sugaring. She likes to do crafts and gardening and spend time with family, friends, and her dog Callie.

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