Should I Refinance My Mortgage?
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What is Mortgage Refinancing?

Mortgage refinancing is the process of replacing your current mortgage with a new loan to either lock in a lower interest rate, adjust your loan term, or even take cash out of your home. Refinancing requires completing a new mortgage application , although some lenders and certain loan products may offer a "streamline" process that eliminates some paperwork and costs.

In other words, a lender will again scrutinize your credit history, debt-to-income ratio, employment history, income, and home equity stake to determine if you qualify for a new loan. The refinance application process may also call for a home appraisal and inspection.

Common Reasons to Refinance your Mortgage

You may look to refinance your original mortgage for a variety of reasons. But they are all usually aimed at one goal -- saving money. Of course, refinancing a mortgage isn't suitable for everyone; make sure you understand all the associated risks and costs to be sure it’s the right choice for you. Here are a few good reasons to consider a refi:

To lower your mortgage interest rate

Mortgage rates change frequently based on prevailing economic conditions. If today’s rates are lower than the rate on your existing mortgage, a refinance could reduce your interest cost over the life of the loan.

Of course, mortgage rates directly affect the amount of your monthly mortgage payment. Lowering your mortgage rate by as little as a half of a percentage point will reduce your monthly payment.

Likewise, if you have significantly reduced your debt-to-income ratio or increased your credit score, you might be eligible for a lower rate.

To switch your mortgage type

Refinancing allows you to convert from one loan type to another. For example, you could switch from an adjustable to a fixed-rate mortgage.

Adjustable-rate mortgages offer low introductory rates during their initial fixed rate phase, making them attractive if you want to hold your home for a short period, say three to seven years.

However, if your fixed-rate phase ends and you still own the home, you'll enter an adjustable-rate period in which your rate fluctuates based on an index. At that time, your rate may go down or it may go up, and may be allowed to rise substantially.

Should rates rise, you could face rising or even unaffordable monthly payments. As many ARMs have rates that change every six months or once per year after the fixed-rate period ends, you could end up with unpredictable payments for a portion of your loan term.

A good way to avoid this scenario is to refinance your adjustable-rate mortgage into a more stable and predictable fixed-rate mortgage.

A homeowner might also refinance not to change the loan term, but rather to be able to escape paying for mortgage insurance. FHA-backed loans require borrowers to pay MI for as long as they hold the loan; refinancing into a conventional loan allows for MI to be canceled when the borrower reaches a 20% equity stake.

To change your loan term

You can refinance to either shorten or lengthen your loan term. If you ’re looking to build your home equity much faster, refinance to a shorter loan, like a 15-year or 20-year loan. A shorter loan term can bring a higher monthly payment, but it also means that you’ll pay a lot less interest over the life of the loan. Shorter-term loans are often available at interest rates below those offered for 30-year mortgages.

On the other hand, a longer mortgage term of, say, 30 years lowers your monthly mortgage payments because you'll be spreading out your mortgage loan payments over a more extended period. Re-starting your loan term all over again at a new 30 years can lower your payment and ease your monthly budget, but keep in mind that you may pay higher total interest costs in the long run.

To tap into your home equity

You can borrow money against the equity you've built in your home using a cash-out refinance. A cash-out refinance lets you replace your current loan with a larger one and receive the difference in cash. It’s suitable for homeowners in need of funds to cover high-interest debts (debt consolidation), home improvements, as a down payment for a second home, or any other purpose.

You wont be allowed to empty out all of the equity in your home, however. Most lenders cap your cash-out amount to 80% of the current value of your home, so if your home is worth $200,000 and you owe $150,000 on your first mortgage, your new mortgage amount will be capped at $160,000 - so you'll only be allowed to extract $10,000 of your $50,000 in equity.

How Much Does it Cost to Refinance a Mortgage?

While refinancing may save you money every month, refinancing can come with upfront fees and closing costs that may outweigh the benefits of refinancing. Part of this depends on how large a break in payment you receive and how long you keep the new mortgage you ’re getting. The cost of refinancing can vary, but generally, the total cost of refinancing falls between 2% to 5% of the original loan’s remaining principal.

There are ways to pay loan fees that can affect when (or if) you achieve savings. Some lenders may allow you to roll refinancing fees into your new loan balance, reducing up-front refinancing costs; others may allow you to trade off paying fees in exchange for a slightly higher interest rate on your new loan. Regardless of how they are paid, here are some of the fees associated with refinancing:

• Loan origination fee - Charged by the lender for processing and underwriting your new loan. Usually costs 0.5% to 1% of the loan amount.
• Mortgage discount points - Paid upfront by a borrower to get a lower interest rate. Generally, one mortgage point will cost you 1% of your mortgage loan amount. Paying discount points is voluntary, but can help you get the lowest possible mortgage rate.
• Title insurance fee - This fee covers the title policy that protects the lender’s interests. The cost ranges between $1,000 to $2,000.
• Title search fee - Paid to a title company to check for any liens against your property since your last transaction. It might cost you between $75 to $300.
• Appraisal fee - Charged by an appraiser to determine your current home value for your refinance. Usually ranges between $200 to $600, but it can be more in high-cost areas.

This is a partial list; there may be other fees for refinancing your mortgage. A good way to see how much you can expect to pay to refinance is to review your existing loan documents - your Closing Disclosure will spell out all the fees you paid for your current loan.

Understanding the Break-even Point

The break-even point is the number of months your interest savings will take to cover the cost of refinancing. A simple rule of thumb is to divide the total of the costs you'll pay by the amount you'll save each month. The result is the number of months it will take to get back the money you spend on refinancing - after that, you'll actually start to save money.

For example, if you spend $2,000 to refinance your loan and your monthly payment was $200 lower, you'll need 10 months in your new mortgage to reach your break-even point. While this simple rule can be helpful, it doesn't provide an accurate means of showing if your refinance really saves you money.

This is why HSH’s "Should I Refinance my Mortgage?" calculator looks beyond your loan’s "break-even point", taking into account any fees you'll pay plus the interest you already paid on your existing loan and the interest you are slated to pay on your new loan. By factoring in both up-front and long-term costs, the calculator shows whether your refinance will actually save you money in the long run (or not) and exactly how long any savings may last.