Does it make sense for you to refinance your mortgage? These are the 4 things to consider

"These are unprecedented times when it comes to refinancing -- because it makes sense for most people," says Rocket Mortgage's Bill Banfield.


Should you refinance your mortgage? It's a complicated question -- and a variety of factors will determine whether or not it makes financial sense for you right now. But if you bought your house before 2020, or haven't refinanced since then, it's worth giving the question some serious thought. Interest rates are so low -- like, near their all-time, historic lows -- that, for the vast majority of homeowners in the US, a refinance will likely make sense. And yet interest rates are just one part of doing the math for your own situation.

There are a lot of benefits to refinancing, including lowering your monthly payment, nailing down a shorter loan term and potentially taking cash out to finance home improvements, consolidating debt and ridding yourself of expensive mortgage insurance. Once you identify your "why" you'll be in a better position to move forward. 

"The decision to refinance really depends on how long you've had your mortgage, what the existing terms of that mortgage are and how long you're planning on retaining any type of mortgage on your existing property," said Robert Heck, vice president of mortgage at Morty, an online mortgage marketplace. "Depending on how somebody answers those questions will determine whether or not refinancing makes sense."

Here's an overview of the four major factors to consider when weighing whether refinancing makes sense for you and your personal situation.

Your interest rate

How your existing interest rate compares with current rates will play a major part in deciding whether a refinance makes sense. A low interest rate may just provide enough of an impetus on its own, and historically low rates will increase the likelihood of a refi making sense for you. Though rates are starting to creep upward, they still remain low, with the average 30-year fixed-rate just over 3% and the average 15-year fixed-rate mortgage hovering around 2.5%. You have to watch mortgage rates carefully, though, as they change daily.

"These are unprecedented times of volume" when it comes to refinancing, said Bill Banfield, executive vice president of capital markets for Rocket Mortgage. "Why is there a lot of volume? Because it makes sense for most people." 

Your equity

If you bought a home 10 years ago and have paid a decade's worth of interest on the principal toward a 30-year fixed-rate mortgage, you're going to be in a much different position than someone who bought their home two years ago or has been making interest-only payments on an adjustable-rate mortgage. Using a mortgage calculator or looking at amortization tables can help you figure out how much principal and interest you've actually paid down.

And you may have paid off more of your mortgage than you realize. With a fixed-rate mortgage, "the percentage of your monthly payment that's going toward building equity in your home goes up over time. That's not always very obvious through your mortgage statements," Heck said.

One option that makes sense for some homeowners with solid equity in their house is a cash-out refinance. Cashing out isn't for everyone, but has grown in popularity as home values rose across the country in response to the COVID-19 pandemic. As homeowners simultaneously gained more equity in their houses while also spending more time at home, the idea of taking money out and putting it back in through home improvements became more appealing to many Americans. But if you aren't looking to do something particular like home improvements, a cash-out may not make much sense. 

Your mortgage type

The type of mortgage you currently have will also help determine whether refinancing is a sound financial decision. If you have an adjustable-rate mortgage and your monthly payments have been paying off interest but not principal -- a common feature of ARMs -- refinancing could actually end up costing you more over time. 

You need to figure out whether your upfront costs combined with the lower interest rate on a newly refinanced mortgage will actually cost you less than your current interest payments, Heck advises. That equation will depend on your specific type of loan.

Another common type of loan is an FHA loan. With the backing of the Federal Housing Administration, an FHA loan is designed for people with a blemished credit history or not enough savings for the traditional 20% down payment. In 2021, you can secure an FHA loan with only 3.5% down -- but you'll be required to buy mortgage insurance, which will increase your monthly payment. Some FHA loans also have higher interest rates than a conventional fixed-rate mortgage. 

Refinancing can allow you to get rid of mortgage insurance while also lowering your rate, a win-win. "If you're in a FHA mortgage, it's the perfect time to think about refinancing into a conventional mortgage and getting out of any mortgage insurance," said Banfield.

How long you plan to stay in your home

If you plan to move soon, refinancing may not make sense. 

Typical closing costs are 2% to 5% of your loan -- about $2,400 on average in 2021, according to Bankrate. Many homeowners roll closing costs into their new mortgage to avoid having to come up with a sizable lump sum, but you'll need time to recoup the expense.

If you plan to say goodbye to your house in the next two or three years, a refi probably doesn't make financial sense, said Linda McCoy, board president of the National Association of Mortgage Brokers.

The bottom line

One of the most common mistakes people make is assuming that all loans and all rates are the same, McCoy said.

"There are thousands of different programs and rates," she said. "People think because their friend got one rate they should get that rate, but they don't understand there are so many variables that make up the rate that you're going to get, like your credit score and your loan amount."

Before you can officially refinance, you need to have good credit, and proper documentation for critical aspects of your financial life like proof of income, bank statements and debt-to-income ratio. From there, a mortgage lender or broker will determine if you are qualified to refinance.

No matter your reason for refinancing, you should only do it if you stand to benefit financially over the long term. "You're really trying to make sure that you're truly getting a net tangible benefit out of the refinance," Heck said. Otherwise, historically low interest rates or not, you won't gain any financial advantages.