When Does Refinancing Make Sense?

Refinancing your home can bring a range of benefits.

Refinancing your home can bring a range of benefits.

Although your mortgage still has 20 years and $250,000 on it, you're not always stuck. Refinancing your mortgage may help you lower your rate, but that's not the only time refinancing makes sense. Just remember that refinancing closing costs typically run between 3 and 6 percent of the amount of the refinance, and refinancing might cause early repayment penalties to kick in, so refinancing isn't for everyone.

Lower Interest Rate

If you signed up for a fixed-rate mortgage, your interest rate won't change automatically to reflect market changes. For example, if you sign a fixed-rate mortgage at 7 percent and rates fall to 5 percent, you'll likely save on your payment if you refinance at the lower rate. According to "The New York Times," experts say the drop in interest rate should be at least 0.25 percent to 1 percent for refinancing to make sense. In addition to changing market conditions, you might qualify for a lower interest rate if your credit score has improved.

Lock in Low Rates

If, on the other hand, you took out an adjustable-rate mortgage, your mortgage rate moves along with the market. When interest rates go down, so does your mortgage. However, if you anticipate rates are going to rise, you might want to refinance to a fixed-rate mortgage as long as rates are low. That way, if rates rise in the future, your rate won't. The downside is that if rates fall even lower, you'll have to refinance to get the lower rate.

Cash Out Refinance

If you've paid down your mortgage but you need extra money, a cash-out refinance might make sense for you. With a cash-out refinance, you borrow more on the new refinance than you previously owed. By adding the amount to your mortgage, you can usually obtain a lower interest rate than if you took out an unsecured loan and you might be able to deduct the interest. Obviously, the downside is that you're guaranteeing the loan with your home so if you can't make your payments, you could lose your home.

Changing Your Mortgage Term

Another reason refinancing might make sense is if you want to extend your mortgage term. For example, if you had to take a lower-paying job or you or your spouse decided to stay home with your baby, you might have trouble making the same mortgage payments as you could afford when you had two incomes. When you refinance, you can select a longer term that will reduce your monthly payments. You'll pay more interest over a longer repayment period, but if you can get a lower interest rate on the refinance, that can offset some of the costs.


About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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