Instead, focus on the big picture. How much more will the loan cost you over its lifetime? When is your break-even point? Are you even saving money?

I’ll address these questions for you below.

What Does it Mean to Refinance?

First, let’s look at the definition of refinancing.

When you refinance, you pay off the mortgage you have now with a new mortgage. It could be a mortgage at a lower rate, a different term, or even a higher loan amount.

A rate/term refinance means you refinance just to get a better interest rate or term. Some homeowners refinance to lower their rate by 1% or more. Others refinance to get out of an adjustable-rate and into a fixed rate or to refinance out of a 30-year term into a 15-year term.

A cash-out refinance means you refinance for an amount higher than what you owe. You can only do this if you have equity in your home. Equity is the difference between your home’s value and the amount of mortgage that’s outstanding. You receive the difference after paying off the first mortgage to use how you want.

Either way, you have a new mortgage with a new payment and a new term. Is it a good idea?

Is Refinancing Right for You?

This is the biggest question – is refinancing right for you? Here’s how to tell.

What is the Loan’s Cost?

This is the most important question. Refinancing isn’t free. Even if you score a no-closing cost loan, there is still the matter of interest.

Before you decide to refinance, look at the Loan Estimate. This is the document every lender must send you after you apply to refinance.

On the Loan Estimate, you’ll see how much interest and principal you’ll pay in 5 years. You’ll also see the total interest paid compared to the loan amount. Use these numbers to decide if refinancing is right for you.

Since most mortgage loans are heavy on interest in the first 5 – 10 years, you may not get as ahead as you thought by refinancing. Sure, you may lower the interest rate, but if you’re already a few years into your current term, you’re paying more principal than interest, if you start over, you’re paying more interest than principal and not saving as much as you thought.

What’s your Break-Even Point?

Your break-even point is one of the most important factors when deciding to refinance. Your break-even point is the point that you pay back the closing costs and earn the loan’s savings.

Let’s say, for example, you can save $200 a month by refinancing but the loan costs you $10,000 to close. You really aren’t saving that $200 a month yet because you had to spend $10,000 to get that $200 a month savings.

You wouldn’t realize the savings for 50 months or a little more than 4 years. If you won’t live in the home for much more than 4 years, refinancing doesn’t make sense.

On the other hand, if you plan to live in the home for the next 20 years, you’d save $38,000 on interest – not a bad deal, right?

But, if you moved in 3 years, the loan would actually cost you $2,800 just to get that $200 lower monthly payment – doesn’t make much sense, right?

Pros and Cons of Refinancing

Now that you know what to look for when refinancing, let’s look at the pros and cons.

Pros:

  ● You may get a lower interest rate

  ● You may change the loan’s term to a more attractive term

  ● You can tap into your home’s equity using the cash for other reasons

Cons:

  ● You’ll pay closing costs that take away from your savings

  ● You could take out more equity than you can afford to pay

  ● You may not save money if the closing costs are too high

How to Decide if Refinancing is Right

So how do you decide if refinancing is right for you?

See what you qualify for and determine if it makes sense. Look at the big picture, not just the interest rate. Focus on the closing costs, the extra interest you’ll pay restarting your term, and how long it will take you to break even.

Also, consider this. If you already paid on your mortgage for many years, you may restart your term, which means adding years onto your mortgage.

For example, if you had your mortgage for 10 years already and you refinance into another 30-year term, you just added another 10 years onto your loan. Now instead of paying your loan off in 30 years, it will take 40 years – doesn’t make much sense right?

If you plan to refinance, try to choose a term that’s as close to the time you have left on your loan. In our example above, you could find a 20-year term versus a 30-year to avoid adding 10 years to your loan.

Final Thoughts

Does it make sense to refinance?

It depends on the situation. If you can truly save money over the life of the loan and not just monthly, it makes sense. Just don’t focus on the lower interest rate or even on a different term. Look at the numbers. How much will you pay out of pocket when it’s all said and done?

Your home is the largest investment you’ll make in your lifetime. Make the most out of it by ensuring your financing doesn’t take away from your profits.