Should you refinance your mortgage? A beginner’s guide

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Getting a mortgage to buy a home can be challenging. But refinancing that mortgage after you’ve bought your home is often much easier.

There are excellent reasons to refinance and factors you should consider before you decide.

Good reasons to refi

Save money

Refinancing can help you save by lowering your interest rate and payment. You might be able to get a lower rate if market rates have dropped, you’ve improved your credit or you originally got a loan for more than 80 percent of your home’s value and your new loan will be for less than that percentage. You can also save by getting rid of your lender’s mortgage insurance, if you have it, and refinancing into a new loan without it. Mortgage insurance is often required if you buy a home or refinance with a loan for more than 80 percent of your home’s value.

Cash out

The difference between your home’s value and the amount you owe on your mortgage is known as your equity. If you have equity, you may be able to borrow against it and get a lump sum when you refinance. This is known as a cash-out refi. The advantages are that you’ll be able to spend the cash however you want and you’ll typically pay a lower rate than you would for a credit card or personal loan. The disadvantage is that if you don’t make your payments, you could lose your home. If you don’t have much equity, you might be able to refinance with private mortgage insurance (PMI) or by getting an FHA loan that’s insured by the Federal Housing Administration, a VA loan guaranteed by the Department of Veterans Affairs, or a USDA loan insured by the U.S. Department of Agriculture.

Lock in a fixed rate

If your current loan has a variable interest rate, your rate and payment could rise. Examples of variable-rate loans include an adjustable-rate mortgage, known as an ARM, a hybrid loan with an initial fixed rate, a home equity loan and home equity line of credit, called a HELOC. Refinancing to swap a variable rate for a fixed one or to combine two loans into one could protect you from the financial risk of a rising-rate loan.

Add or remove a borrower

If you get married, you might want to refinance to add your spouse to your mortgage. If you and your spouse split up, your divorce decree may require that one of you refinance to remove the other from the home loan. Refinancing typically is the only way to remove a borrower from an existing loan.

Rates are low, so why not refinance now? Find the best refinance rates today.

Factors to consider

Break-even analysis

Refinancing isn’t free. Whether you pay your closing costs out of pocket, add them to your loan amount or accept a higher interest rate in exchange for a so-called no-closing-costs loan, you will have to absorb some costs. These could include escrow or attorney fees, title insurance and an appraisal. If you want a super-low rate, you might have to pay an additional upfront fee known as a discount point to get it.

One way to decide whether refinancing makes sense is to divide your costs by your monthly savings to figure out how soon you’ll recoup the expense. For example, if you paid $2,500 to refinance and saved $150 each month, it would take you about 16 months (2,500 divided by 150) to recoup your costs. This calculation is known as a break-even analysis.

Income tax makes this analysis a bit more complicated. If you normally itemize your deductions, you might want to ask your tax preparer for advice about how refinancing would affect your tax liability.

If you’re planning to keep your new loan longer than your break-even point, that could be a factor in favor of refinancing.

Use our mortgage refinance calculator to help you decide whether a refi is right for you.

Total interest savings

Another way to think about refinancing is to compare the total interest you’d pay on your current loan if you kept it until it was paid off with the total interest you’d pay on your new loan if you kept that until it was paid off.

A mortgage calculator can help you make the comparison. A refinancing calculator lets you input the details of your current loan (e.g., loan amount, rate, balance and years left to pay it off) and your proposed loan (e.g., loan amount, rate and term) to find out how much interest you’d pay over the loan’s lifetime.

Mortgage calculators have some limitations. For example, you might not be able to see the full effects of an adjustable rate, mortgage insurance or income tax.

If you want to get the benefits of refinancing, you’ll have to connect with a mortgage broker or loan officer at a mortgage company, bank or credit union. An expert can help you make the right decision for your personal situation.

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