For many homeowners, the idea of refinancing your mortgage can sound like a financial cure-all: You submit some paperwork, and then the lender determines if you’re eligible and gives you a different mortgage with new terms — potentially saving you up to thousands of dollars in interest over the life of your loan.
But the details of refinancing are more complicated than that. Before deciding to refinance, homeowners also need to consider the cost of refinancing, and how long they plan to own the home.
So, is refinancing worth it? It’s a big question, and the answer depends on your finances and your goals. Let’s take a closer look:
- How Refinancing Can Help Homeowners Save Money
- The 1 Percentage Point Rule of Thumb
- Calculating Your Break-Even Point
- How Much Could You Save From Refinancing a Mortgage?
- The Bottom Line on Deciding When Refinancing Is Worth It
How Refinancing Can Help Homeowners Save Money
With the right terms, the savings could add up quickly when you refinance. Here are some popular reasons to refinance a mortgage:
- Reduce the interest rate. One of the most common reasons to refinance is to lock in a lower interest rate than you pay now. This could help qualified homeowners save up to thousands of dollars in interest over the life of the loan.
- Reduce the monthly payment. A lower interest rate with the same term could reduce your monthly mortgage payment, and give you more room in your budget for other priorities.
- Pay off the loan more quickly. Refinancing to a shorter loan term means you’ll be mortgage-free more quickly.
- Protect yourself from rate increases. If you have an adjustable-rate mortgage, your monthly payment can change to reflect market interest rates. If those rates spike, your monthly payment will, too. Refinancing to a fixed-rate mortgage locks in the same rate for the life of your loan.
- Consolidate debts into a single, affordable payment. A cash-out refinance allows you to borrow your home’s equity, which is the difference between the property’s market value and your mortgage principal. Qualified homeowners could save money by repaying high-interest debts like credit cards at a lower interest rate and over a longer period as part of their mortgage.
Read More: Should I Refinance My Mortgage?
The 1 Percentage Point Rule of Thumb
When deciding whether to refinance, most homeowners look for a lower interest rate. But how low does the rate need to be to make it worth refinancing?
Most lenders suggest following an industry rule of thumb: “If your rate is 1% to 2% below your current one, then it makes sense to refinance,” says Kris Lippi, a real estate broker and owner of ISoldMyHouse.com, based in Manchester, Connecticut.
Let’s use an example with a 30-year, fixed-rate mortgage that has an outstanding balance of $250,000, an interest rate of 4%, and a monthly payment of $1,194. If you refinanced to a 30-year, fixed-rate mortgage for the same amount at a 3% interest rate, then the monthly payment would drop to $1,054. That’s a savings of $140 each month.
Others say it makes sense to refinance when rates are 0.75 percentage points below your current rate.
“I know from experience that lowering the interest rate by at least 0.75% is worthwhile,” says Bob Scott, a real estate investor and founder of Sell Land, based in St. Louis. “It doesn’t seem like a lot, but interest is compounding and 0.75% can generate (for) you added monthly savings.”
Related: 10 Questions To Ask Before Refinancing
Calculating Your Break-Even Point
As you shop for a lower interest rate, it’s important to calculate your break-even point and understand what it means. The break-even point is how long it will take for your savings on a lower monthly payment to cover the cost of refinancing. Since the average closing costs on a refinance are about $5,000, breaking even on this expense could take a while.
Check Out: How To Reduce Your Refinance Closing Costs
“You have to find out how long it may take for your refinancing to pay for itself,” Lippi says. To calculate the break-even point on a refinance, he says, “Divide your mortgage closing costs by the monthly savings that you will get from a new mortgage.”
For example, if your refinance closing costs are $5,000 and the new loan saves you $175 a month on your mortgage payment, it would take about 29 months for the savings to recoup the closing costs. After that point, the lower mortgage payment entirely represents savings.
Running a break-even analysis is important when you’re wondering how to decide if a refinance is worth it. If you plan to sell your home before reaching the break-even point, refinancing might not be worth it.
How Much Could You Save From Refinancing a Mortgage?
The savings potential will vary dramatically based on your mortgage details. But it’s possible to unlock big savings.
“Savings can be in the tens of thousands of dollars depending on how long they keep the new mortgage,” says Rebecca Richardson, a senior mortgage consultant at Wyndham Capital in Charlotte, North Carolina.
If you aren’t sure how much a refinance could help you save, consider running the numbers with a refinance calculator. You can play around with the calculator to decide when is it worth it to refinance.
Is it worth refinancing to save $100 a month?
Saving money on your mortgage is usually a good option. But you may still be wondering, is it worth refinancing to save $100 a month?
Say you bought your home with a 30-year, fixed-rate mortgage for $250,000 at a 4% interest rate. After four years of making the monthly payment of $1,194 (not including taxes and insurance), you’ve reduced your principal to $231,284 and paid $38,574 in interest.
Lowering your monthly payment by about $100 — to pay $1,094 a month — would require you to refinance to a 30-year, fixed-rate loan at a 3.92% interest rate. You would pay a total of $162,392 in interest on that new loan. Add that to the interest paid on your first mortgage, and your total interest cost would be $200,966. Staying with your original loan instead would result in a total interest cost of $179,674 — meaning that refinancing to save $100 a month would end up costing you $21,292 more in interest.
Is it worth refinancing to save $200 a month?
Reducing our original payment example by about $200 — to pay $994 a month — requires refinancing to a 30-year, fixed-rate loan at a 3.15% interest rate. You would pay a total of $126,525 in interest on the new loan. When this amount is added to the $38,574 paid on the original loan, the total comes to $165,071 — which means you would save $14,575 in interest.
If you instead focus on reducing your interest rate, you could save even more. Refinancing the above mortgage to a 30-year, fixed-rate loan for $231,284 at a 3% interest rate lowers your monthly payment to $975 — which is $219 less per month — and your total interest comes to $119,753. That saves you $21,347 in interest over the original loan.
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The Bottom Line on Deciding When Refinancing Is Worth It
So, when is it worth it to refinance? Only you know when it’s right for your situation and goals. Take the time to do the math and determine your break-even point based on the current market interest rates. That way, you can decide if refinancing is worth it for you.