House Loan Refinancing: When It Makes Sense and How to Calculate Your Savings

What Is Mortgage Refinancing?

Mortgage refinancing is the process of replacing your existing mortgage with a new loan, using the new loan proceeds to pay off the old loan. Essentially, you take out a new mortgage that pays off your current one, and you begin making payments on the new loan. Refinancing can be done with your current lender or a different one.

The new loan may have different terms, including a different interest rate, loan term, or type of mortgage. For many homeowners, the goal is to secure more favorable terms that reduce their monthly payment, save on interest, or help them achieve other financial objectives.

• Refinancing replaces your existing mortgage with a new loan.
• The new loan proceeds are used to pay off the old loan.
• Terms such as interest rate, loan term, and loan type may change.

Sources: Fannie Mae, CrossCountry Mortgage, Zillow, Bankrate

Common Reasons to Refinance

Homeowners refinance for a variety of reasons, depending on their financial goals and current mortgage terms. The most common motivations include reducing the interest rate, lowering monthly payments, shortening the loan term, or adjusting the type of mortgage.

Some homeowners refinance to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage for more predictable payments. Others use a cash-out refinance to tap into their home equity for major expenses, while some refinance to cancel private mortgage insurance (PMI) once they have enough equity.

• Lowering the interest rate
• Reducing monthly payments
• Shortening the loan term
• Switching from an adjustable-rate mortgage to a fixed-rate mortgage
• Canceling mortgage insurance
• Obtaining cash through a cash-out refinance
• Consolidating debt

Sources: Fannie Mae, CrossCountry Mortgage, Zillow

Costs of Refinancing

Refinancing is not free. Like your original mortgage, a refinance involves closing costs, which typically include an appraisal, title search, origination fee, and other lender fees. These costs can add up significantly and are a key factor in determining whether refinancing makes financial sense.

Estimates for typical closing costs range from 2% to 6% of the new loan amount, depending on lender and location. The exact amount varies, so it is important to get a detailed breakdown from your lender.

Some lenders offer 'no-closing-cost' refinances, where the closing costs are rolled into the loan amount or offset by a slightly higher interest rate. While this reduces upfront expenses, it increases your loan balance or raises your monthly payment, so it is essential to compare the long-term cost.

• Typical closing costs range from 2% to 6% of the new loan amount.
• Closing costs can include appraisal, title, and origination fees.
• No-closing-cost refinances roll fees into the loan or trade for a higher rate.

Sources: Fannie Mae, CrossCountry Mortgage, Zillow

How to Compare Your Current Loan with a Refinance Offer

To evaluate whether refinancing is worthwhile, you need to compare your current loan with the proposed refinance loan using a mortgage calculator with refinancing options. The key is to look at both monthly payments and total interest over the time you expect to keep the new loan.

Start by calculating the monthly payment for your current loan and for the new loan. Use the same loan amount for the refinance scenario (typically your current remaining balance) and factor in any new loan term. Then, compare the monthly payment difference. A lower payment may come from a lower interest rate or a longer term, so you also need to consider the total interest paid.

Use an amortization schedule to compare the principal balance after the same number of payments. For example, if you plan to stay in your home for five more years, compare the principal balance after 60 payments for both loans. If the refinance loan has a lower principal balance at that point, you are building equity faster, which is another benefit.

1. Determine your current loan balance, interest rate, and remaining term.
2. Get a refinance offer with the new rate and terms.
3. Use a mortgage refinance calculator to compute the new monthly payment.
4. Compare monthly payments and total interest over your expected time in the home.
5. Check the amortization schedules to compare principal reduction after the same period.

Sources: Zillow

Break-Even Point: When Refinancing Pays Off

The break-even point is the number of months it takes for your monthly savings from refinancing to cover the total cost of the refinance. If you plan to stay in the home longer than the break-even period, the savings will eventually outweigh the costs.

To calculate your break-even point, divide the total closing costs by the monthly savings. If you expect to move before the break-even point, the savings may not justify the upfront costs.

This calculation helps you make an informed decision, but it is not the only consideration. There are also non-financial factors, such as the desire to switch from an adjustable rate to a fixed rate or eliminate mortgage insurance, which may make refinancing worthwhile even if the break-even period is longer.

• Break-even point = total closing costs ÷ monthly savings.
• If you plan to keep the loan longer than the break-even period, refinancing may be worthwhile.

Sources: CrossCountry Mortgage, Zillow, Navy Federal Credit Union