How to know if refinancing is worth it

With mortgage rates hitting a 3-year low, you might be mulling over the possibility of refinancing. Wondering if refinancing is worth it? As refinancing is an important decision and can have a significant impact on your financial future, you'll want to weigh refinancing benefits against its downsides and costs.

Here, we'll go over exactly what it means to refinance a mortgage, when a refi is worth it and when it's not, and how to go about making your decision.

What does ‘refinancing a mortgage’ mean?

Refinancing a mortgage is replacing your existing loan with a new one, sometimes even with a different lender. When you refinance, you can potentially lock in a lower interest rate, shorten your loan terms, swap your equity to take cash out, or to change your loan type – think from a fixed-rate to an adjustable-rate mortgage.

Refinancing can mean monthly savings or more affordable payments. Whatever the benefits are, it's important to weigh the pros against the cons to see if it's a worthwhile move for you.

What is the break-even point?

The break-even point when you refinance is when the savings on refinancing are greater than the costs, such as appraisal fees, credit report fees, origination fees, and attorney fees.

To figure out your "breaking even" point, you can use a mortgage refinance calculator. Not only can such a handy tool help you figure out the break-even point, you can see what to expect in the way of potential monthly and yearly savings.

Should you refinance?

Whether it's worth the hassle and extra costs depends on whether it's a sound financial move for you – both in the long- and short-term. Also, determine whether this move aligns with your goals.

You'll want to know what your new terms will be – mortgage rates, monthly payments, and the loan term. If you're mulling over a cash-out refinance, what do you plan on using the proceeds for?

It's a good idea to look closely at the terms, such as late fees and any prepayment penalties. That way, you won't get blindsided.

When is refinancing a good idea?

Let's look at some scenarios when it makes sense to refinance a mortgage.

1. Mortgage interest rates have decreased

When mortgage interest rates see a dip, you could save money on the total interest fees, bump down your monthly payment, or both.

For example, if you refinance on a 30-year-fixed mortgage to a lower interest rate, and keep the loan at the same length, you'll find that your monthly payments can go down. In turn, that can free up cash to spend, save, or throw toward your debt.

Refinancing to a new mortgage with lower interest rates also means you'll save on interest on the total loan. For example, if you go from a 30-year-fixed mortgage with a 7.0% APR to one with a 6.0% APR, this can lower your monthly payment by $65 and you'll see savings of $2,863 in total interest. Your break-even point is 52 months.

2. You want to change mortgage terms

You might want to change your type of mortgage or your loan term. For example, if you prefer to lengthen your loan, which can mean a lower monthly payment, it could alleviate the squeeze of a hefty housing bill.

On the flip side, let's say you're considering going from a 30-year to a 15-year mortgage. In that case, while your monthly housing costs can ramp up, you'll be free and clear of your mortgage sooner. This could mean you can attain a different lifestyle, work less, or move toward personal, professional, or financial goals.

Play around with different mortgage terms and types to see how that might change your monthly payments and how much you could potentially pay across the life of your loan.

3. You want to switch from an adjustable rate to a fixed rate

A fixed mortgage rate, which means predictable, steady payments, can help you stay on top of your mortgage payments. And if you're securing a lower interest rate, this can help safeguard you from interest rates, should they go up in the future.

Considering going from a variable-rate to a fixed-rate loan? Fixed-rate loans can have an initial interest rate, which is lower to begin with. After the initial interest rate is up, it kicks over to the normal interest rate. However, the rate can also go down as interest rates go down. And if you plan on speeding up the payoff on your mortgage, it could save you money.

Interest rates can also have caps on how much they can go up during the loan term, or at any given time.

4. You need to tap into your home’s equity

You might refinance on your home if you need to tap into your home's equity. With a cash-out refinance, you swap your existing mortgage for a larger one, and pocket the difference in cash. It allows you the chance to tap into existing equity.

Maybe you want to access that equity to put toward starting a new business, or for home improvements. Whatever the reason, it's important to have a plan for the cash you'll receive from refinancing your home, and that it'll help propel you toward a goal.

5. You need to consolidate higher-interest debt

If you're refinancing to consolidate higher-interest debt, you can benefit by taking out a new loan with lower interest. Another potential benefit? It can help you streamline payments. Lenders usually like to see an 80% loan-to-value (LTV) ratio, which means you'll need at least 20% equity in your home.

Tips to maximize the value of refinancing

Here are our pointers for making the most of refinancing:

• Shop around for the best terms. Loans and lenders aren't created equal. Get some quotes for different mortgage types from a handful of different lenders, and see what terms and rates you qualify for. That way, you can ensure you're scooping up the best rates possible.
• Negotiate terms or closing costs. If it's a buyer's market, you might have an easier time negotiating the terms of the mortgage. For example, trying to negotiate for a lower origination fee or dropping some of the concessions.
• Match your remaining loan term. If you get approved for a lower interest rate but keep the same loan term, you can save on the interest rates.
• Improve your credit score over time. If you're not in a rush to refinance your mortgage, finding ways to bolster your score can mean securing more favorable interest rates and terms. The stronger your credit, the better your odds.
• Time your refinance with rate drops. Refinancing your home so it's in step with mortgage rate drops can equal savings on the interest. Keep an eye out for rate drops and proceed accordingly.

The bottom line: Be strategic when you refinance your mortgage

Refinancing can certainly mean lower interest rates, lower monthly payments or both. You'll want to understand the pros against the cons and figure out when it's an optimal scenario to refinance. That way, you can ensure it's a worthwhile move.

If you're a Rocket Mortgage customer, you can speak to a Home Loan Expert if you need help paying your mortgage and to explore your options.

Rocket Mortgage is a trademark of Rocket Mortgage, LLC or its affiliates.

Refinancing may increase finance charges over the life of the loan.

The VA Streamline program may have stricter requirements in some states. In order to qualify for the VA Streamline program, you must have a VA loan. The VA Streamline is only available on primary residences. Cash-out transactions are not allowed. In order to qualify for a VA Streamline, a 0.5% minimum reduction in interest rate on the previous fixed-rate loan must occur if the new loan will be a fixed rate or a 2% minimum reduction in interest rate on previous adjustable rate mortgage loan must occur; a minimum of 6 months of consecutive mortgage payments must be paid on the current loan at the time of application. Some states may require an appraisal. Additional restrictions/conditions may apply.

Rocket Mortgage is a VA-approved lender, not endorsed or sponsored by the Dept. of Veterans Affairs or any government agency.

The FHA Streamline program may have stricter requirements in some states. In order to qualify for the FHA Streamline program, an immediate .5% minimum reduction in interest and mortgage insurance premium is required. Some states may require an appraisal.