Refinancing your mortgage is a powerful way to restructure your finances. It can help you meet your financial goals by potentially reducing your interest rate and monthly payment, allowing you to pay off your loan more quickly, letting you borrow cash for major expenses, or eliminating the need to pay for private mortgage insurance.
Here are nine reasons to refinance your home that could save you money.
If you’re struggling to afford your mortgage payment, refinancing often can reduce significantly that monthly bill — and open up some room in your budget.
“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.
Refinancing to a lower interest rate can save homeowners hundreds per month, but it usually comes at the cost of a longer loan term and paying more interest overall. Even if interest rates have increased, refinancing to a longer loan term still can reduce your monthly payment, though it will cost you more in interest.
Let’s say you bought a home for $250,000. You made a 20% down payment and took out a 30-year fixed-rate mortgage for $200,000 at 4.5% interest. The monthly payment for principal and interest on that loan is $1,013. After 10 years of making payments, the balance on your mortgage is $160,179, and interest rates have gone up. Refinancing the balance into a new 30-year loan with an interest rate of 6% would reduce your monthly payment to $960 — saving you $53 per month.
To get that reduction, you’ll have to pay closing costs on your new loan, which average $5,000 on a refinance. You also will be extending your loan payoff date by 10 years, and you’ll pay $102,518 more in total interest.
Refinancing To Lower Your Monthly Payment Example
2. Pay Off the Loan Sooner
Homeowners often refinance from a 30-year loan to a 15-year loan to finish repaying their mortgage more quickly. This likely will increase your monthly payment, but it also will save you a lot of money on interest.
“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 $160,179 you owe on your existing loan to a 15-year fixed-rate mortgage at 5.75%, then your monthly payment would be $1,330. That’s $317 more per month, but you’ll finish paying off your mortgage five years sooner — and you’ll save $3,783 in interest.
With closing costs, your new loan would be slightly more expensive. The real advantage comes with the early repayment of the loan, after which you’d own the house free and clear.
Refinancing To Pay Off Your Loan Sooner Example
3. Stop Paying for Mortgage Insurance
If you bought a home with a down payment of less than 20% of the purchase price, you likely pay between $30 and $70 per month for every $100,000 borrowed for PMI, which protects the lender in case you default. You can stop paying for PMI when your home equity — the difference between what your home is worth and what you owe on it — is more than 20% of your home’s value.
Your home equity grows in two ways. The most reliable way is by paying down your mortgage principal, but it also can grow if your home’s value increases. If your home’s value grows enough that you can refinance with 20% equity before reaching that point with monthly payments, you can eliminate the need to pay for PMI.
Say you bought your home for $300,000 and made 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 7%. You’d have to pay PMI for 130 months — almost 11 years — before your equity would reach the 20% mark of $60,000. If your PMI payment is $75 per month, you’d pay a total of $9,750 for insurance in that time.
But if your home appreciates in value by 3% each year, your home in five years will be worth $344,782, and your loan balance will be $268,275. Refinancing that balance would give you 23% equity, which means you can skip six years of PMI payments, saving you $5,400.
Remember, this is offset by the need to pay closing costs, which average $5,000 on a refinance.
4. Save On Total Interest
Refinancing to a lower interest rate or a shorter loan term — or both — can save you from paying thousands in interest.
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%. 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 $168,179 to a 15-year fixed-rate mortgage with an interest rate of 3% would cost you $38,931 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, a cash-out refinance will let you borrow your equity as cash and repay it as part of your new mortgage. This can save you money because interest rates for mortgages usually are much lower than they are for other types of debt. Plus, you would have fewer bills to keep track of, and be able to repay your debts over a longer time, which can add breathing room to your monthly budget.
Some people sign up for an adjustable-rate mortgage to get the low introductory interest rate, only to encounter increases in their interest rate and monthly payment once it expires. 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 may borrow equity with a cash-out refinance, which means they take out a bigger mortgage based on the current value of their home, repay their old loan, and keep the difference. This often increases the monthly payment or loan term, but can help homeowners afford major expenses such as home improvements or renovations, 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 it on 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 the larger payments. But if the numbers make sense, a cash-out refinance can help you reach your financial goals.
8. Remove a Co-Signer
Refinancing your mortgage means replacing your old loan with an entirely new one. That lets you change almost every aspect of it, including the people listed on the loan.
If you had a co-signer when you initially got the mortgage, refinancing is one way to remove them. For example, if you had a parent co-sign the mortgage to help you secure the loan or get a lower rate, refinancing will release them of that responsibility.
Keep in mind that removing a co-signer also removes their credit from the equation when your lender underwrites the loan. You’ll need to have adequate credit and income to qualify for the new mortgage without a co-signer.
9. Switch Loan Types
There are many mortgage types out there, and refinancing can let you change from one to another.
For example, jumbo mortgages are intended to help people buy homes that are more expensive or are located in high-cost areas. However, they may have higher rates than conforming conventional loans because Fannie Mae and Freddie Mac cannot buy those loans from lenders. Refinancing to a conforming loan could help you get a lower interest rate.
You also could consider refinancing to another type of loan, such as a U.S. Department of Agriculture loan or Veterans Affairs loan. These loans have strict eligibility requirements, such as only being available for homes in rural areas or to veterans, but offer benefits such as no minimum down payment, low closing costs, and competitive interest rates.
When To Consider Refinancing Your Home
To help you decide when to refinance your home, here are some situations that suggest you could benefit from refinancing:
- 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 and pay off your loan early. Both could save you money in the long term.
- You have equity in your home. Equity gives you options. It can let you refinance to stop paying for PMI, get better terms on a new loan, switch loan types, or borrow against it with a cash-out refinance, home equity loan, or home equity line of credit.
- You need cash for major expenses. Borrowing your equity is especially useful when you use it to pay for home improvements that further increase your home’s value, or on assets with long-term value, such as a college education.
- You need to consolidate high-interest debt. With mortgage rates typically a lot lower than interest rates on credit cards, student loans, or personal loans, it can save you money and time to borrow equity to pay off high-interest debts. You then repay those high-interest debts as part of your mortgage payment.
When To Avoid Refinancing Your Home
Some situations that suggest it may be a poor choice to refinance include:
- Interest rates have increased. Raising the rate of your mortgage can mean a huge increase in the loan’s overall cost. For example, a 30-year loan for $100,000 at 5% interest would cost $193,230 overall, while the same loan at 6% would cost $216,000 — an increase of $22,770.
- You’re more than halfway through your loan term. Extending the term of a loan means you’ll pay more for it overall. If you extend it by a large amount, you’ll wind up paying so much more overall interest that the lower monthly payment isn’t worth it.
- You’re planning on moving soon. Refinancing involves paying closing costs. If you sell your home and move shortly after paying closing costs, you won’t have saved enough to make refinancing worth it. “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.”
- You lack sufficient equity. If you have little equity built up, lenders may be unwilling to refinance your mortgage.
FAQ: Reasons To Refinance Your Home
Here are answers to common questions about reasons to refinance your home.
Refinancing a mortgage means replacing your existing loan with a new one. You still only have one loan. A second mortgage means taking on an additional loan and having two loans at once.
Mortgage rates recently have risen to levels unseen over the past decade. That can mean refinancing to a higher interest rate, which could lead to a more expensive loan over time. Still, you may still find a good reason to refinance — say, if your credit has improved, or if you want to change loan programs or remove a co-signer.
The Bottom Line on Reasons To Refinance Your Home
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.
T.J. Porter contributed to the reporting of this article.