• If you can get a lower interest rate today than the rate on your current mortgage, refinancing could result in lower monthly payments and/or reduced interest expense over the loan term. 
  • A cash-out refinance allows homeowners with home equity to replace their existing mortgage with a higher-balance mortgage under new terms, effectively converting some of the home equity into cash.
  • There are fees associated with refinancing, so it only makes sense to refinance if the benefits outweigh the costs. 

Knowing when to refinance your mortgage can potentially save you thousands of dollars in interest expense over the life of the loan.

Mortgage refinancing is a useful tool for homeowners. It allows homeowners to replace their current home loan with a new home loan under new terms. 

When done right, refinancing can reduce the interest rate, reduce the monthly payment, or provide access to cash through your home equity.[1]

However, there are some factors that should be considered before refinancing. Under certain circumstances, the monthly payment could increase, or you could end up paying more in interest over the term of the loan.

This article will explain when to refinance a mortgage, giving you the information needed to make the right decision for you. 

When To Refinance a Mortgage

Refinancing a mortgage may be beneficial when you can get a lower interest rate than the rate on your current mortgage. 

Refinancing may also be beneficial when you need to spread the remaining loan balance over a longer period to reduce the monthly payments or a shorter period to repay the loan sooner. 

In some cases, a cash-out refinance may help you convert some of your home equity into cash with a favorable interest rate. This typically works best when interest rates are low and you have equity in the property.[2]

Signs That You Should Consider Refinancing

If any of the following situations apply to you, it may be time to consider refinancing your mortgage.  

  • Current interest rates are lower than they were when you purchased the home. 
  • Your credit score has increased so much that you now qualify for a substantially lower rate than the rate on the current mortgage. 
  • You currently have an adjustable-rate mortgage (ARM) that you want to convert to a fixed-rate mortgage to “lock in” current interest rates. 
  • You currently have a fixed-rate mortgage that you want to convert to an ARM, so your interest rate will automatically adjust with the market going forward. 
  • You need a lower monthly payment, which could be achieved by spreading the remaining loan balance across more years of repayments. 
  • You have built enough home equity to eliminate any private mortgage insurance (PMI) requirement.
  • You want to convert some of your home equity into cash while changing the terms of the current mortgage. This cash could even be used to pay off high-interest debts, reducing your overall interest expense across multiple debts.

It is important to note that these are not surefire signs that you should refinance. Rather, these are signs that you should consider refinancing by taking a closer look at current interest rates and your present financial situation. 

How Refinancing a Mortgage Can Be Beneficial

Refinancing your mortgage under the right conditions may provide notable benefits. 

Lowering Monthly Payments

You can lower the monthly mortgage payment by securing a lower interest rate, extending the loan term, or both.  

Assume, for example, that a homeowner took out a $300,000 30-year mortgage with a 7% fixed interest rate. Five years into the term, the homeowner would pay around $1,996 per month for principal and interest. If the homeowner can refinance to a new 30-year loan with a 6% fixed rate (with a 3.5% refinancing fee included in the new loan), the payment would go down to around $1,752, saving the borrower $244 per month.[3]

It is important to understand that extending the loan term to lower the monthly payment may mean paying more in total interest expense. In the example above, the borrower would end up paying around $22,193 more in total interest by refinancing.[3]

Reducing Overall Interest Expenses

You can reduce the overall interest expense by securing a lower rate, reducing the loan term, or both. 

Using the example above, what if the borrower refinanced to a 20-year loan instead of a 30-year loan? All other terms being the same, the borrower would save $106,102 in total interest expense and own the home free-and-clear five years earlier than expected. However, the monthly payment would increase by $98, even with the lower interest rate, because the remaining balance is being spread across fewer payments.[3]

Locking in a Low Rate

Some borrowers with an ARM may want to refinance to a fixed-rate mortgage to lock in current rates for the term of the loan. 

Converting an ARM to a fixed rate replaces the uncertainty of automatically-adjusting interest rates with the stability of a set interest rate. A fixed-rate mortgage means more predictable monthly payments, which can make it easier to budget for the future.  

Allowing the Rate to Automatically Adjust To Changing Market Conditions

Some borrowers with a fixed-rate mortgage may want to refinance to an ARM so their interest rate can automatically adjust with the ever-changing market. 

ARMs offer lower introductory rates than fixed-rate mortgages. If interest rates drop in the future (after any fixed-rate period), the rate will automatically decrease, resulting in lower monthly payments without any action taken by the borrower. However, if market rates increase, the interest rate will automatically increase, resulting in higher monthly payments for the borrower. 

Converting Some of Your Equity to Cash (Cash-Out Refi)

One of the perks of homeownership is the power to build equity in your home. As you pay down the mortgage and/or the value of the home increases, your equity grows. A cash-out refi is one of the ways to convert some of that equity into cash. 

With a cash-out refi, you can borrow against your equity while refinancing the existing home loan.

Using the same figures as in the earlier example, assume that a homeowner took out a $300,000 30-year mortgage with a 7% fixed interest rate five years ago. Now, assume the homeowner can refinance to a new 25-year loan with a 6% fixed rate (with a 3.5% refinancing fee included in the new loan) and pull $20,000 in cash out of the equity. In this case, the monthly payment would only increase by $21, and the homeowner would save $24,398 in total interest expense over the life of the loan.[3]

Factors Influencing the Decision To Refinance

When deciding whether or not to refinance, consider the following factors.

Current Interest Rates

It is best to refinance when current rates are considerably lower than the rate on your existing home loan. While there is no magic number that works for all homeowners, an interest rate drop by as little as .5% could be enough to consider refinancing.[4]

Your Credit Score

If your credit score is substantially higher today than when you applied for the current home loan, perhaps by 20 points or more, you might qualify for a lower interest rate (depending on how the market rate has changed since then).

The Current Value of Your Home

If the home’s value has declined since the purchase, you might not qualify for refinancing with a lower interest rate than the current loan. 

The Cost of Refinancing

The fees associated with refinancing vary based on a number of factors. In many cases, you can finance the fees, rather than paying them upfront. Financing these fees may cost you a bit more in interest expense, but it makes the costs much easier to absorb.

Any Prepayment Penalty

If your current mortgage has a prepayment penalty, this amount would need to be paid prior to refinancing. 

The Break-Even Point

Because there are fees associated with refinancing, it may take some time before the financial benefits outweigh the cost of the refinance. The point at which the refinance savings exceed the cost is the break-even point. If you sell or refinance again before reaching that break-even point, you will have a net loss from the refinance.[5]

The break-even point is calculated by dividing the closing costs by the monthly savings. For example, if the refinance costs $5,000 and the monthly savings is $250, the break-even point is 20 months (5,000 / 250 = 20). You would need to remain on this payment schedule for 20 months before seeing the financial benefit of the refinance. 

When To Avoid Refinancing

In general, you should avoid refinancing if the costs outweigh the benefits. This can happen when:

  • Your new interest rate would be higher than the rate on the current mortgage. 
  • Your credit score has declined enough to prevent you from qualifying for a refinance at a lower interest rate. 
  • It would take too long to see the benefit of a lower rate.
  • The house has been converted from a primary residence to an investment property, and the investment property rate would not be worth refinancing. 

How To Decide When You Should Refinance

To see if a mortgage refinance is beneficial for you, enter your figures into PNC Bank’s Mortgage Refinance Calculator.

Final Thoughts

Refinancing under the right circumstances can provide impressive financial benefits like lower monthly payments, lower interest expenses, and even cash in your pocket. If you can get a lower interest rate 

Knowing when to refinance your mortgage and when not to empowers you to capitalize on the advantages of refinancing while minimizing any risk. 

Learn more about refinancing and explore your options with PNC Bank.