If you’re a homeowner looking to save money, mortgage refinancing could help with that. In the short term, refinancing could lower the monthly payment or give access to cash. In the long run, it could save qualified homeowners up to thousands of dollars over the life of their loan through lower interest rates or a faster loan payoff, or by eliminating the need to pay for private mortgage insurance.
Here’s a breakdown of seven reasons to refinance your home — and when’s a good time to do it.
The most significant and immediate benefit qualified homeowners could see from refinancing a home is a lower monthly mortgage payment.
“The most common reason someone decides to refinance is when current interest rates are lower than the interest rate they currently have, which often reduces the monthly payment,” says Whitney Hansen, a money coach and personal finance podcaster based in Boise, Idaho.
A lower interest rate could save some homeowners up to hundreds of dollars a month — though refinancing also often means you’d be paying your loan for a longer period. It’s a good idea to do the math and understand the change to your total interest costs over your loan term.
As an example, let’s say you bought a home 10 years ago for $250,000. You made a 20% down payment and took out a 30-year, fixed-rate mortgage for $200,000 with an annual percentage rate of 4.5%. The monthly payment for principal and interest on that loan is $1,013. After 10 years, the balance on your mortgage is about $160,000, so refinancing to a new 30-year, fixed-rate mortgage at 3% APR would reduce your monthly payment to $675. That would save you $338 per month — but you’ll be making payments for 10 years longer than if you hadn’t refinanced.
2. Pay Off the Loan Sooner
When you refinance, you might have the option to shorten your loan term. Homeowners will often refinance from a 30-year loan to a 15-year loan to finish repaying their mortgage more quickly. While a shorter loan term may increase your monthly payment, it could also result in a lot of savings on the overall interest you’d pay, making it one of the more practical reasons to refinance your home.
“Refinancing to a short-term loan with a higher monthly payment can make a lot of sense if you are trying to pay off the loan faster,” Hansen says.
Revisiting the example above, if you refinanced the $160,000 or so still owed on your existing loan to a 15-year, fixed-rate mortgage at 3% APR, then your monthly payment would be $1,105. That’s $92 per month more than the payment you’re making with the original loan, but you’ll finish paying off your mortgage five years sooner.
3. Stop Paying for Mortgage Insurance
If you buy a home with a down payment of less than 20% of the purchase price, your lender will likely require you to pay a monthly fee for private mortgage insurance. PMI costs between $30 and $70 per month for every $100,000 borrowed. The insurance protects the lender in case you default, and you typically must continue paying for it until you have 20% equity, which is the difference between what your home is worth and how much you still owe on the mortgage. Making your monthly payments will build the equity in your home over time.
In another example, say you’re buying a home for $300,000 with a 5% down payment, which is $15,000. You finance the remaining $285,000 with a 30-year, fixed-rate mortgage that has an interest rate of 3%. Assuming the home’s value remains stable, you would have to pay PMI for 82 months — almost seven years — before your equity reaches the 20% mark of $60,000. If your PMI payment is $50 per month, you’ll pay a total of $4,100 for insurance.
But if your home increases in value, that also adds to your equity. You could refinance using the home’s higher market value and stop paying PMI. Just remember that refinancing costs money — average closing costs run about $5,000 — so you’d need to plan to own the home long enough to recoup those costs for refinancing to make sense.
4. Save on Total Interest
Reducing your monthly mortgage payment can be helpful in the short term, but saving up to thousands of dollars on interest over the life of your loan may be even better.
A lower interest rate or shorter loan term allows you to save on interest every month, even if you wind up with a higher mortgage payment. If you’re able to refinance to a lower rate, a shorter term, or both, you’ll likely save a lot of money compared to your current loan.
Related: Why Are Mortgage Rates Important?
Let’s revisit our example of the home purchased 10 years ago with a 30-year, fixed-rate mortgage for $200,000 at 4.5% APR. You’ll pay $164,813 in total interest, of which you have already paid $83,030 and will pay $81,783 more over the remainder of the loan term. Refinancing your loan balance of $168,178 to a 15-year, fixed-rate mortgage with an APR of 3% would cost you only $38,888 in interest — a savings of $43,895 over your original mortgage.
If you have credit cards, auto loans, personal loans, student loans, or other debts, you can refinance to borrow some of your equity as cash to pay them off. This effectively rolls those debts into your mortgage, which can save you money because mortgage rates are typically much lower than interest rates for other types of debt. Plus, you would have fewer bills to keep track of and be able to repay your debt over a longer period, which can add breathing room to your monthly budget.
Some people sign up for an adjustable-rate mortgage to get a low introductory interest rate, not fully considering their monthly payment may increase in the future. If this applies to you, it may make sense to refinance your ARM to a fixed-rate mortgage.
With a fixed-rate mortgage, your interest rate and monthly payment are set for the life of the loan. Escrow payments for taxes and insurance can change, but the principal and interest payments do not, ensuring some long-term financial predictability.
Some homeowners could borrow equity with a cash-out refinance, which means they take out a bigger mortgage based on the current value of their home, replace their old loan, and keep the difference. This often increases the monthly payment or loan term, but can help homeowners cover major expenses such as home renovations or repairs, unexpected medical bills, or college tuition.
You can use the money from a cash-out refinance any way you like, but it’s best to avoid spending the funds on things like fancy vacations or a new car, which don’t have long-term value, Hansen says.
Keep in mind that your mortgage is secured by your property, so you risk foreclosure if you can’t afford larger payments. But if the numbers make sense, a cash-out refinance can help you reach your financial goals.
When you’re debating the pros and cons of refinancing your home, you should consider your current mortgage, your refinance options, and how long you plan to own the home.
If you decide to refinance, Hansen suggests paying close attention to the fine print so there aren’t any unpleasant surprises after signing your paperwork. It’s also important to beware of fraud, especially if you’re required to wire money to an escrow account.
“Be very, very careful and ensure you follow your lender or title company’s instructions for where to send the money,” Hansen says. “If you receive any emails requesting the money be sent to a specific account, watch out! Fraud with mortgages is very common.”
To help you decide when to refinance your home, here are some specific factors to consider.
Your finances have improved
If your credit score has increased, you might be able to refinance to a lower interest rate. Or, if your general finances have improved — say you’re making more money at a new job — you could refinance to a shorter-term mortgage and pay off your loan early. Both could save you money in the long term.
You must pay refinance closing costs
Closing costs vary by location and property value, but typically include appraisal fees, tax service fees, title insurance, government taxes, and some prepaid expenses. So, should you refinance your mortgage and pay these costs?
“Refinancing is not a great idea if you are not planning on staying in your home long enough to recoup the costs of refinancing,” Hansen says. “You might save money on the monthly payment, but the closing costs paid to refinance your mortgage will take time to recover.”
Doing the math lets you find out how long it will take your savings from a lower interest rate or monthly payment to recover what you need to pay in closing costs.
Learn More: How To Reduce Your Refinance Closing Costs
When should you refinance your home? The best time is when the conditions are right to help you save money overall, whether that’s through a reduced monthly payment, lower interest rate, shorter loan term, or something else. Now that you understand some of the most common reasons to refinance your home, you can make the right decision for your financial future.