Should You Refinance Your Mortgage?: 7 Questions to Ask

What Questions You Should Ask Before Refinancing

If you're a homeowner, there may come a time when you ask yourself an important question: Should I refinance my mortgage?

This question may come up if you notice interest rates dropping, if you want to change the terms of your current loan, or if you are hoping to take equity out of your home.

There's not one right answer to this question, though. So, if you're considering a home refinance, there are actually seven questions you should ask yourself to decide if refinancing is right for you. Here's what they are.

1. Are Today’s Rates Lower Than Your Current Rate?

A rate drop is one of the most common reasons to refinance your home. Your interest rate is the cost you pay to borrow. If you can lower that rate by refinancing, then your loan will cost you less money.

Depending on your current loan term and the loan term on your new refinance loan, you may be able to lower your monthly payment, lower interest costs over the life of the loan, or both.

You have up-front closing costs to pay when refinancing, though. These need to be considered when deciding is refinancing worth it. If closing costs are $5,000 and you save $150 a month by refinancing, it would take you around 33 months or 2.75 years to break even on the closing fees.

A home refinance calculator can help you estimate your savings so you can decide when to refinance based on how much you'll save and how long it will take to cover the upfront costs.

2. Do You Have Plans to Sell Your Home?

Because you must pay closing costs of refinancing up front, it doesn't make sense to refinance if you plan to sell your home soon. If you won't break even before you sell, you should stick with your current home loan.

Doing the math on when you'll break even is key to determining when to refinance mortgage loans. As mentioned above, you can do this by dividing the amount of upfront closing costs by the monthly savings to see how long it will take to break even. Don't refinance if you'll sell before that time.

3. How Many Years Are Left on Your Mortgage?

As you're deciding when should I refinance my mortgage, it's important to consider the loan term. That's the time it takes to pay back your loan. There's a tradeoff when you pick your loan term:

• A loan with a shorter term comes with higher monthly payments but lower borrowing costs over time.
• A loan with a longer term comes with lower monthly payments but higher borrowing costs over time.

The longer your loan term, the lower your payment each month, but the more expensive it is to repay your loan because you pay interest for a longer period.

If you have 10 years left on your original 30-year mortgage and you refinance to a new loan with a 30-year loan term, you set the clock back. Since you will pay interest for much longer, you will likely increase total borrowing costs even if you lower your rate.

Refinancing to a new loan with a shorter repayment timeline allows you to avoid this, but you'll have higher monthly payments since you have less time to pay back the full balance. You'll save over time, but pay more each month until you're debt-free. A refi calculator can help you compare monthly payments and total costs to find a loan term that works for you.

4. Are You Paying Mortgage Insurance?

Mortgage insurance is required on certain loans, and you may want it removed if you're currently paying it. This is a factor when deciding when does it make sense to refinance a mortgage.

If you have a conventional loan and you now have at least 20% equity in your home, you don’t need to refinance to eliminate PMI. You can also request your lender remove it from your loan.

The rules are different for the mortgage insurance premiums (MIP) that come with FHA loans.

• If you bought your home with an FHA loan and initially put less than 10% down, you will have to pay for mortgage insurance for the life of the loan. You'll need to refinance your loan to stop paying mortgage insurance.
• Even with more than 10% down, you'll still owe premiums for 11 years unless you refinance.

It can make sense to refinance to eliminate PMI when you can qualify for an affordable new loan that won't have these insurance costs.

5. What’s Your Current Credit Score?

You can't answer the question, should I refinance my home, without considering your credit score.

While it's sometimes possible to refinance with bad credit, loans for bad credit borrowers are often more expensive and come with higher fees. If you have excellent or very good credit, on the other hand, you stand a better chance of qualifying for an affordable refinance loan that saves you money compared to your current mortgage.

Applying to refinance does result in an inquiry on your credit record, and too many inquiries can cause a temporary reduction in your score. So, don't apply to refinance until you are sure you are ready -- which means having the best credit score possible to qualify for competitive rates.

6. What Are You Hoping to Accomplish?

There are advantages to refinancing home loans, but there are also downsides, including closing costs and lots of paperwork. To make sure that the upside outweighs the downside, it's helpful to ask yourself: Why should you refinance?

Refinancing should be done only if you have a clear purpose for doing so. That purpose might be to:

• Lower your interest rate
• Reduce your monthly payment
• Save money over the life of the loan
• Change your loan term
• Adjust the type of loan you have
• Pull cash out of your home using a cash-out refinance loan
• Eliminate PMI
• Get a cosigner or joint borrower off your loan

By defining your goal for refinancing, you can make sure that securing a new home loan will actually allow you to achieve that objective. You may also find that refinancing isn't the best option and that you should consider an alternative such as a home equity loan or line of credit.

7. What Type of Mortgage Do You Have?

Finally, think about the type of refinance loan that you have, as this can affect the answer to the question, should you refinance home mortgage loans.

• If you have an FHA or VA loan, you may be able to simplify the refinancing process by taking advantage of a VA streamline refinance or an FHA streamline refinance. Since these loans can be cheaper and easier to qualify for, there are fewer downsides. In fact, a VA interest rate reduction refinance loan (VA IRRRL) is specifically designed to make this possible.
• It can also make sense to refinance if you have an adjustable-rate mortgage and want to switch to a fixed-rate mortgage, or vice versa. ARMs come with rates that adjust over time, but which usually start lower. Fixed-rate loans offer a higher starting rate but more predictable payments since your rate and payment won't change.

Depending on whether you think rates are going up or down, it may make sense to switch from an ARM to a fixed-rate loan or a fixed-rate loan to an ARM. Making this change is a reason to refinance as you can't change your terms with your current lender.

All these factors should be considered as you decide when should you refinance your home loan.

When To Refinance FAQs

Still deciding if refinancing makes sense? Here are the answers to some frequently asked questions people have about when they should refinance their home loans.

How Soon Can I Refinance After Buying?

How soon you can refinance after buying depends on the lender's policies. You may be able to refinance immediately, but some lenders require your loan to become seasoned first, which means you must wait around 6 months.

How Many Times Can I Refinance?

There is no limit to how many times you can refinance your home loan. Be mindful of the fact that there are closing costs to pay with each refinance, though. You also don't want to keep refinancing and extending your loan term, as that will make payoff costlier and cause you to take longer to become debt-free.

What Are the Costs Associated With Refinancing?

You must pay closing costs to refinance a mortgage. These costs typically add up to 2% to 5% of the amount borrowed. Closing costs include payments for things like an appraisal and title insurance.

Final Thoughts: Are You Ready to Refi Your Mortgage?

Now you know how to answer the question, should you refinance your mortgage? If you have good credit, can qualify for an affordable rate, and have a goal for refinancing, then you may wish to move forward.

You should speak with a mortgage loan officer to understand what your refinance loan might look like in terms of your mortgage rate, loan term, monthly payment, and total borrowing costs. This can help you decide if refinancing is right for you.