The homebuying process can be stressful, with pressure coming at you from every angle—sellers, real estate agents, lenders, you name it. The process also tends to fly by quickly, especially in demanding markets. In the midst of the homebuying chaos, you likely obtained a mortgage. And if you’re like most homebuyers, you didn’t have the luxury of shopping around for months (or years) to find a loan with the perfect terms.
Now, you make your payments dutifully each month, maybe glancing at the balance now and then. But mostly, they don’t cross your mind much anymore.
That is, until one day, you hear a friend mention they refinanced and lowered their payment, or interest rate changes become major headlines. Your life circumstances could evolve as well, and things look different now than they did when you first signed those loan documents.
These changes may spark a simple question with a deceptively complicated answer: Should I refinance my mortgage?
A lower interest rate sounds appealing, and a smaller monthly payment sounds even better. But refinancing isn’t always the right answer, despite what lenders promise.
Before assuming refinancing is either an obvious move or not worth the hassle, consider first what refinancing actually involves, what it costs, and when it might (or might not) make sense for you.
Refinancing refers to the process of replacing your existing mortgage with a new one.
In simple terms, you take out a new loan, use it to pay off the old mortgage, and begin making payments on the new loan instead. The new mortgage may have a different lender, interest rate, term length, payment amount, or structure. Or in some cases, all of the above.
The refinancing process is similar to the steps you and your lender took when obtaining the home’s original mortgage. You apply for the loan, provide documentation about your income and assets, go through an underwriting process, and, if approved, close on the new mortgage.
Many homeowners refinance at least once during the life of their loan, though lenders tend to see the biggest uptick when rates drop drastically. For example, lenders experienced “refinance booms” in 2003 (following the dot-com bubble burst) and 2020. Both periods experienced rapid rate drops of at least 200 basis points.1
Similar to your original loan, refinancing comes with closing costs. Refinancing costs typically range from 2% to 5% of the loan amount, depending on the lender, location, and complexity of the loan.2 If you’re refinancing a $300,000 mortgage, for example, your closing costs may be between $6,000 and $15,000.
This includes things like:
If you don’t have the cash to cover the closing costs upfront, you may have the option to “roll” them into the new loan. For example, instead of paying that $15,000 in fees on a $300,000 refinance, your new loan amount becomes $315,000. Just keep in mind, rolling in your closing costs means you’re essentially financing them, which increases your monthly payments and interest.
That being said, it’s important to understand what refinancing your mortgage will cost, especially if you plan on selling your home in the near future. Say refinancing drops your monthly payments by $300, but the closing costs are $15,000. You wouldn’t “breakeven” on refinancing your mortgage until you’ve made 50 mortgage payments (equaling a little over four years).
If you plan on living in your home for the foreseeable future, it may be well worth the additional upfront costs. But if you plan on selling anytime soon, consider calculating the trade-off beforehand.
A drop in interest rates is one of the most common reasons homeowners refinance, but it’s not the only reason. Here are some scenarios in which it might make sense to refinance your mortgage:
Interest rates rise and fall over time, often gradually and sometimes dramatically. In 2020, as we mentioned earlier, the Federal Reserve cut rates aggressively to stimulate the economy. As a result, long-term interest rates dropped, and mortgage rates hit historic lows. For the first time in recent history, 30-year mortgages hit the 2% to 3% range.3
If your mortgage was obtained when rates were closer to historical averages, say around 7%, that kind of drop could have a major impact on your monthly payment.
Here’s a simple example: On a $200,000 mortgage at a 7% interest rate (ignoring taxes, insurance, and PMI), your monthly payment would be about $1,330. If you refinanced that same loan at a 3% rate, your payment would drop to roughly $843. That’s nearly $500 less per month, or close to $6,000 per year.
Keep in mind, major rate changes like this are uncommon. Rather, rates tend to move slowly, and a modest rate drop might not be enough to offset closing costs.
During or after a divorce, couples will commonly sell the family home and split the proceeds or have one person remain in the home while the other moves out. When one spouse keeps the house, refinancing is often the most straightforward way to put the mortgage solely in their name.
Doing so can benefit both parties for two reasons. First, it removes the departing spouse from financial liability, which is often required as part of a divorce decree. Second, it gives the remaining spouse full control over the loan going forward.
Refinancing can also be useful when you want to add someone to the mortgage, such as a new spouse or partner, or remove a previous co-signer. While there may be alternatives, refinancing is often the most straightforward way to realign your home loan with your current situation.
Your original mortgage terms may have made perfect sense at the time, but that doesn’t mean they’re still ideal today.
Adjustable-rate mortgages (ARMs), for example, often start with lower rates than fixed mortgages, which can be appealing upfront. But once the adjustment period ends, rates can rise, sometimes sharply. If you’re approaching that point, refinancing into a fixed-rate loan can provide more long-term stability and predictability.
You may also be inclined to shorten the length of your loan. If you initially took out a 30-year mortgage, for example, you might later decide to refinance into a 15-year loan. Your monthly payment will likely increase, but you’ll pay the loan off faster and often secure a lower interest rate in the process.
If you’ve made major improvements to your credit score since first buying the home, you may be able to secure a new home loan with a better rate or terms as well.
You could tap into some of your home’s equity by doing a cash-out refinance.
With a cash-out refinance, you take out a new loan that’s larger than what you currently owe and receive the difference in cash. Because the loan is secured by your home, interest rates are often lower than what you’d pay on credit cards or personal loans.
Some people use this strategy to consolidate high-interest debt, fund a major renovation, or cover a large one-time expense. When used strategically, this type of refinancing can help simplify your debt and lower borrowing costs. Just keep in mind, it increases the amount you owe on your home, and you’ll need to weigh the trade-offs carefully.
Refinancing may be worth considering if it meaningfully improves your cash flow or better aligns the loan with your current life circumstances. That said, there’s a possibility the cost of refinancing could outweigh the long-term benefits—especially if your timeline to selling the home is short.
If you’re considering making a change to your existing home loan, you may benefit from speaking with a professional. A financial advisor can help review your current situation and assess the impact refinancing will have on your greater financial picture.