What to Watch for When Refinancing Your Home Mortgage
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A smart refinance can save you thousands, but only if you know how to avoid costly pitfalls, calculate true savings and choose the right loan for your goals. When you purchase through links on our site, we may earn an affiliate commission. Here’s how it works. Refinancing replaces your current mortgage with a new loan, often to lower your interest rate, shorten your loan term or lock in a fixed rate. Some homeowners also choose a cash-out refinance, which lets you tap your home’s equity and receive a lump sum for larger expenses.As housing markets shift and personal finances evolve, many homeowners periodically reassess whether their mortgage still fits their needs. Changes in income, home equity, debt levels or long-term plans can all create opportunities, or reasons to consider refinancing.Still, refinancing isn’t automatically a win. Closing costs, extended loan terms and aggressive lender offers can quietly add thousands of dollars to your total cost. Before you apply, it’s important to understand the warning signs, run the numbers and make sure a refinance truly aligns with your financial goals.Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special IssuesProfit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.Profit and prosper with the best of expert advice - straight to your e-mail.Refinancing can be financially smart, but not every offer is created equal. Some lenders rely on confusing terms, aggressive marketing or hidden costs that can quietly increase what you’ll pay over time.Be aware of warning signs and red flags that you might see when refinancing a mortgage: Refinancing your home can help you get a lower interest rate, but you’ll also need to pay closing costs. Calculating your break-even point, which is the point at which your interest savings will cover the closing costs, can help you determine whether refinancing makes sense.To get started, add up all of your closing costs, including lender fees, title costs and escrow services. You’ll also need to determine how much your new mortgage will save you per month; you can do that by subtracting your new monthly mortgage payment from your old monthly mortgage payment.To calculate your break-even point, divide your total closing costs by your monthly savings. The resulting figure is the number of months that it will take before your savings will cover the closing costs and you’ll break even.For example, if your closing costs are $6,000, and you’ll save $250 per month, it will take 24 months before you break even on your refinancing.A common rule of thumb can help you decide when to refinance. If you have a 30-year mortgage, a 0.75% drop in interest rates will usually result in positive savings after three years, often justifying the cost of refinancing. With a 1% drop, you’ll break even in about 20 months.Generally speaking, if interest rates have dropped by 0.5% or less, refinancing may not be worth it, since you won’t reach your break-even point in a reasonable amount of time.When you refinance, you have the option to extend the loan term, taking a longer time to pay down your mortgage. Extending the loan term on a 30-year refinance could end up costing you more over time, since it starts amortization over again.When you start paying on your new 30-year mortgage, your initial payments are interest-heavy, which increases your cost. Even if you have a lower interest rate, the longer mortgage term and interest could mean you’ll ultimately pay more. To avoid this scenario, consider refinancing while maintaining your loan term or even shortening your mortgage to a 15-year term if you can comfortably afford the payments.Get practical insights on real estate, interest rates and smart money moves delivered straight to your inbox every weekday.Subscribe to Kiplinger’s daily newsletter, A Step Ahead.Even if you avoid obvious red flags, refinancing can still come with less visible costs that affect your long-term finances. Understanding these potential traps can help you make a more informed decision.Be aware of several other refinancing traps that could cost you money:Different lenders offer different terms and interest rates, so it’s important to shop around and compare quotes from different lenders. Request at least three quotes from different lenders and pay attention to factors like interest rates, closing costs and loan terms.Consider getting offers from credit unions, online lenders and mortgage brokers, since they may offer lower interest rates and better overall terms than larger traditional banks and lenders.Refinancing can offer benefits to some homeowners, but make sure that it makes sense for your specific situation. For example, if your refinance break-even point is in five years, but you plan to move within the next two years, refinancing doesn’t make financial sense, and you’ll pay more to refinance than you’ll save. Think about how long you plan to stay in your home to determine if you should refinance now.You also need sufficient equity in your home to be able to refinance. According to A+ Federal Credit Union, you’ll generally need at least 20% equity in your home. Some lenders will work with you if you have less equity, but chances are you’ll need to pay private mortgage insurance until you build up 20% equity again, which adds onto the cost of refinancing and pushes your break-even point further out.If you don’t have a strong credit score, refinancing may not make sense, either. Lenders often consider borrowers with poor credit scores as being higher risk, so they charge a higher interest rate to make up for that risk. If you’re refinancing to take advantage of a lower interest rate, you may not qualify for that interest rate, especially if your credit score has dropped since you initially bought your home.Before you apply to refinance a mortgage, do some calculations to determine if it makes financial sense.
The Navy Federal Credit Union’s mortgage refinance calculator makes it easy to see how much refinancing could save or cost you.Take some time to talk with a trusted financial adviser or mortgage professional about your goals and what you should consider when refinancing. These experts can provide advice tailored to your specific situation and can also help you spot potential financial pitfalls.Curious about today's refinance interest rates? Use the tool below, powered by Bankrate, to explore and compare some of today's top offers:Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.Paige Cerulli is a freelance journalist and content writer with more than 15 years of experience. She specializes in personal finance, health, and commerce content. Paige majored in English and music performance at Westfield State University and has received numerous awards for her creative nonfiction. Her work has appeared in The U.S. News & World Report, USA Today, GOBankingRates, Top Ten Reviews, TIME Stamped Shopping and more. In her spare time, Paige enjoys horseback riding, photography and playing the flute. Connect with her on LinkedIn.