Is Now a Good Time to Refinance Your Mortgage?
A mortgage refinance can be a good tool for improving your financial position. But just because you can refinance, it doesn’t mean you should.
Several factors need to be considered before deciding if now is the right time to refinance. These factors include current mortgage rates, your financial goals and whether the benefits outweigh the costs.
If you're wondering whether a refi is right for you, we can help you decide. Once you've determined you’re ready to refinance, you can find the right lender by shopping for the best mortgage refinance companies.
- Factors to consider when refinancing
- When should you refinance your mortgage?
- How to refinance your mortgage
- Mortgage refinance FAQs
Factors to consider when refinancing
A refi is a big financial decision. It’s essential to take the necessary time to determine if it’s the right choice. Now may or may not be the right time to take that step. Consider the following to help you decide.
Current mortgage rates
According to mortgage experts, a refinance typically makes sense if you can lower your interest rate by at least 0.75 percentage points, although a decrease of 0.50 percentage points could also be worthwhile.
When looking into mortgage refinancing, check the rate on your existing mortgage. This information is on your mortgage statement. Then, shop around with different lenders to check current mortgage rates.
Refinancing could make sense if your existing rate is higher than the rate you qualify for now. However, refinancing is probably a bad idea if your current rate is lower. Why? Because changing from a lower rate to a higher one translates into higher monthly payments over the life of the new mortgage.
Using a mortgage refinance calculator can give you an idea of your new payment and help you decide whether a refi makes sense, given your financial situation.
Your financial goals
You should determine why you want to refinance your mortgage. Do you want a lower interest rate that will result in monthly savings? Or do you want to take advantage of an increase in your home’s value and tap into your equity?
The reason for refinancing will determine the type of loan you should apply for, which in turn will influence the interest rate you could qualify for. Lenders will offer different rates for different loan categories.
A popular type of refinancing is a rate and term refinance. This type of loan is good if you want to get a new rate or change the term of your loan. For example, you could reduce your rate from 7% to 6% or change the life of the loan from 30 years to 15 years.
You can also switch from an adjustable-rate mortgage, which has a fixed interest rate for a set number of years before it becomes variable, to a fixed-rate loan, which has a constant rate.
Another option is a cash-out refinance. A cash-out refi allows you to get a new loan, pay off the old one and use the cash balance to pay for home improvements or renovations, or pay high-interest debts like credit card debt or personal loans.
Remember, however, that if you need to tap into your equity but refinancing doesn’t make sense, you can also consider a home equity loan or home equity line of credit (HELOC).
Your costs vs. savings when refinancing
When deciding whether a refi makes financial sense, you want to calculate your break-even point. This is the number of months it will take to recoup the refinance costs — the sooner you can recover them, the better.
Just as you did when you took out a home loan, you’ll have to pay closing costs on a refinance. These costs can amount to 2% to 6% of the loan amount and are determined by the lender. To calculate your break-even point, you have to take the total cost of refinancing and divide it by how much you’ll save on your monthly payments.
For example, if you have an outstanding balance of $300,000 on a 30-year loan and qualify to reduce your current rate from 7% to 6.25%, you’ll reduce your monthly mortgage payment by $149. If you qualify for a 6% rate, you’ll save $197 per month.
If your total refinancing costs are $18,000 (6% of $300,000) and you reduced your interest rate to 6.25%, your break-even point will be 121 months or about 10 years ($18,000 divided by $149). If you plan on selling your home in less time, refinancing may not be the right choice. Most mortgage experts recommend a break-even point of three to five years.
The example above assumes you are doing a rate and term refinance into another 30-year fixed-rate mortgage and the highest closing costs you might pay. A lower interest rate or reduced closing costs can also lower the break-even point.
If your finances have improved significantly and your budget allows for larger monthly payments, you can also refinance into a shorter-term loan, like a 15-year fixed-rate mortgage, which typically has a lower interest rate. A shorter-term mortgage loan means you will pay off the loan faster and save on interest, but the trade-off is that your monthly payments will be higher.
Current economic conditions
Current economic conditions often influence financial decisions. For example, periods of inflation and recession can affect interest rates on all kinds of consumer debt, from student loans and credit cards to mortgages.
During the pandemic, the Federal Reserve cut short-term interest rates to 0% to stimulate the economy. That decision led to mortgage rates dropping below 3% for the first time, bottoming out at 2.65% in 2021.
These historically low rates led to a real estate boom. First-time and repeat homebuyers were able to make a down payment on larger and more expensive homes while keeping monthly payments low, and a record number of homeowners refinanced their existing home loans.
Starting in 2022, however, consumer prices increased significantly, prompting the Fed to raise interest rates quickly to control inflation. As a result, mortgage rates increased at a stunningly fast pace between January and October, almost reaching 8%. Although inflation has eased substantially since then, it is still higher than the Fed would like.
Today, mortgage interest rates have eased back down but remain significantly higher than they have been over the past few years. Refinancing may not be the right choice for many homeowners, especially those who took advantage of historically low rates in 2020 and 2021 and whose current loan has a sub-4% rate.
However, buyers who took out a mortgage when rates were peaking last year may be able to lock in a lower rate. When evaluating whether to refinance, keep in mind how the state of the economy could influence your decision.
When should you refinance your mortgage?
When you should refinance is more a matter of your financial situation than waiting for the perfect rate.
Don’t try to time the market. Waiting on rate swings is as troublesome as timing the stock market. If you can save money or move closer to your financial goals by refinancing today, don’t wait to see what happens with mortgage interest rates tomorrow.
Consider these key points when deciding whether to refinance your mortgage:
Your credit score
With most mortgage lenders, you’ll need a credit score of at least 620 to qualify for a mortgage refinance. To get the lowest mortgage rate, you’ll need a 740.
Check your credit score. If it’s lower than when you took out your current mortgage, you may not qualify for a rate that is as favorable as you did before. Consider taking steps to improve your score before applying for a refinance.
Your credit report
Your credit score is based on information in your credit report. A lender may offer a higher interest rate if the report contains errors that reflect poorly on you. Request a copy, check it for mistakes, and take steps to correct any errors you find.
Your debt-to-income ratio (DTI)
Your debt-to-income ratio is the percentage of your gross monthly income that is used to pay your monthly debts. Lenders use your DTI to determine your credit risk.
Some lenders will work with a DTI of as high as 43% for conventional loans. FHA loans will go a little higher, usually accepting DTIs of 50%. Lower, however, is generally better.
How long you’re staying
When you refinance, you’ll need to pay closing costs. If you plan to move out in the near future, you may not break even and recover the costs of refinancing. Remember, the sooner you regain the refi costs, the sooner you start saving money.
How much equity you have in your home
In order to qualify for a mortgage refinance, you generally need at least 20% equity in your home, especially if you are applying for a cash-out refinance. Some lenders, however, may be willing to refinance a government-backed loan, like an FHA or VA mortgage, with lower equity.
How to refinance your mortgage
These tips can help you start the refinancing process.
Determine your refinancing goal
Ask yourself what you want to achieve by refinancing. It could be reducing your current interest rate, changing the term of your loan, switching from an adjustable-rate mortgage to a fixed-rate loan or cashing out the equity you’ve built up. Defining a goal helps you narrow down what type of loan best suits your needs.
Consider how the loan term may change
Refinancing may extend or reduce the amount of time you’ll be paying the mortgage. For example, if you have already paid 10 years of your current 30-year mortgage and refinance into another 30-year loan, you will be paying your mortgage for a total of 40 years. If you refinance into a 15-year loan, your total payback time is cut to 25 years.
Shop around for a lender
Look beyond your current lender. Mortgage rates are very variable, and you may be able to find a lower rate by looking at multiple lenders. Consider banks, credit unions and online lenders.
Compare what they offer, then apply to 3-5 lenders that offer the best rate and terms. Your credit score won’t be negatively impacted if you make multiple applications within a 14-day period. If possible, obtain a mortgage preapproval letter from several different lenders and compare the offers.
Calculate your breakeven point
In addition to comparing the rate different lenders offer, calculate your breakeven point, or how long it will take you to recover the cost of refinancing. Closing costs, which include application and origination fees, total between 2% and 6% of the new loan amount and are typically paid upfront.
Calculate your breakeven point by dividing your total costs by the amount you’ll save each month. The result will be the number of months it takes to recover those costs.
Prepare your home for an appraisal
Having your home appraised is part of the refi process. It helps determine the value of your home and can affect how much a lender is willing to refinance. Prep your home by decluttering the interior and sprucing up the yard. Have receipts for any improvements you’ve made, and be present at the appraisal to answer questions.
Lock in your rate
Don’t count on mortgage rates dropping significantly in the foreseeable future. Mortgage experts believe rates will stay elevated through the end of the year. Once you find a rate you can comfortably afford, lock it in.