When Is the Cost to Refinance a Mortgage Worth It?

Are you considering refinancing your mortgage? If so, there are several factors to consider when determining if it’s the best financial move right now. Refinancing your mortgage entails paying off your current mortgage and replacing it with a new mortgage. Since refinancing requires taking out a new loan, there will be fees and paperwork associated with the new mortgage. Even though there is a cost to refinance a mortgage, however, if the timing is right, you may be able to benefit from substantial savings and reduce debt.

How can you know when the cost to refinance a mortgage is worth it? At Capital Credit Union, we are here to help you determine when to refinance and when to wait. In this article, we’ll explore which circumstances can justify the costs and when you might be better off keeping your original mortgage. With these tips, you may be able to pay off your mortgage faster, lower your monthly payments, or own your home outright sooner. Financial freedom is around the corner.

Secure a Lower Interest Rate

One of the main reasons homeowners choose to refinance is to secure a better interest rate. Several factors can influence your rates. Maybe your credit score has improved since you first took out your loan, and you qualify for better rates. Or maybe market interest rates have dropped. Whatever the reason, if you can reduce your interest rate by 1 to 2 percent, it may be the ideal time to refinance your mortgage.

Lowering your interest rate can lead to substantial savings over the life of the loan. It can also reduce monthly payments and increase the rate at which your home builds equity. Free up more of your finances each month to put toward other financial goals. A lower interest rate also means you will pay less in interest over the life of the loan, which can reduce your total loan cost and help you pay off your mortgage faster.

Unsure how much you could save each month? Use a mortgage calculator to estimate what your monthly payments could be with a new loan. Then compare the difference between the monthly payments of your original mortgage with the estimated monthly payments of a new loan. If there is a significant savings each month, the costs of refinancing may be worth it.

Calculate Break-Even Point

Determine whether you can benefit from a mortgage refinance by calculating the break-even point. This refers to the point where you can start saving money from refinancing. When the money you save from a new mortgage exceeds the costs, then you have reached the break-even point.

Mortgage refinance closing costs can be between 3 and 6 percent of the loan’s principal. Like your original mortgage, these costs can involve origination and application fees and paying for an appraisal, title search, and escrow services, including the costs of property tax and insurance. If the savings from a new mortgage outweigh these expenses, it may make financial sense to refinance.

To calculate your break-even point, take your refinancing costs and divide them by the monthly savings from a new mortgage. To do this, add up the closing costs mentioned above. Then subtract your new monthly mortgage payment from your original mortgage payment. Take your total refinancing costs and divide that number by your monthly savings. The number you get is the number of months it will take to recover refinancing costs. You can also use a break-even calculator to do the math for you or talk to your lender for assistance.

If the refinancing costs and interest rate are lower than what you are paying on your current loan, you will likely break even fairly quickly and can benefit from significant savings. If the closing costs or interest are higher, refinancing may not justify these costs.

Shorten the Loan Term

If you can shorten your loan term with a mortgage refinance, you could end up paying significantly less in interest over the life of the loan. Conversely, if refinancing extends your loan term, you could end up spending more in interest and increasing your total loan cost. Compare the term of the new loan to the number of months remaining on your original mortgage. If the new term exceeds the length of the remaining term, you may end up paying more. On the other hand, if it is lower, you could pay less interest overall.

Even if your monthly payment increases slightly, a shorter loan term can still save you a significant amount of interest. For example, if refinancing at a lower rate cuts your loan term in half while only raising your monthly payment by a few dollars, the savings are substantial. However, if refinancing at a lower interest rate reduces your term by half but significantly increases your monthly payment, it may not be worth it. It’s important to compare interest rates, term lengths, and monthly payments to determine how much you would save and if it’s worth refinancing to a lower rate.

Switch to a Fixed-Rate Mortgage or ARM

Different types of loans have different payoffs, depending on your homeownership needs. If you currently have an adjustable-rate mortgage (ARM), you may benefit from refinancing to a fixed-rate mortgage to avoid rate increases. If you refinance to a fixed-rate mortgage, plan on staying in your home for at least five years or until you reach the break-even point.

On the other hand, if you plan on moving soon, you may benefit from switching to an ARM to take advantage of initially lower rates.

The Bottom Line

When is the cost to refinance a mortgage worth it? If you can get a mortgage with a lower interest rate, break even, significantly lower your monthly payment, or shorten your loan term, you may be able to pay off your loan faster and maximize your savings.

However, if you plan on moving soon, your credit score has fallen, or refinancing will extend your loan term and prevent you from reaching the break-even point, this may not be the best time.

Looking to refinance and are wondering if it’s worth it? Schedule an appointment with a Capital Credit Union lending expert. Our team is ready to help you unlock your financial goals.