Refinancing Your Loan: When It Makes Financial Sense

Refinancing a loan means replacing your existing loan with a new one, typically to get better terms like a lower interest rate, different loan term, or to access equity. But refinancing isn't always the smart move—there are costs involved and situations where it doesn't make financial sense. This guide helps you determine when refinancing is beneficial.

Compare your current loan vs a new offer with /finance/loan-calculator and compute your breakeven.

What Is Refinancing?

Refinancing is replacing your current loan with a new loan that has different terms. Common reasons to refinance:

• Rate and Term Refinance: Lower your interest rate or change your loan term
• Cash-Out Refinance: Borrow more than you owe to get cash
• Cash-In Refinance: Put money in to reduce your loan amount
• Streamline Refinance: Simplified refinancing (for FHA/VA loans)

When Refinancing Makes Sense

1. Interest Rates Have Dropped

The most common reason to refinance: you can get a significantly lower interest rate.

Example:

• Original loan: $300,000 at 5.5% for 30 years
• Monthly payment: $1,703
• Total interest over 30 years: $313,258

If rates drop to 4.5%:

• New monthly payment: $1,520 (save $183/month)
• Total interest over 30 years: $247,220
• Savings: $66,038

Rule of Thumb: Refinance if you can lower your rate by at least 0.5-1%.

2. Your Credit Score Has Improved Significantly

If your credit score has improved by 50+ points since your original loan, you may qualify for much better rates.

Common Scenarios:

• Paid off credit card debt
• Improved payment history
• Credit report errors fixed
• Time has passed since financial hardship

Example Impact:

• Original loan with 650 credit: 7.5% APR
• With improved 750 credit: 5.5% APR
• That's 2% interest savings!

3. You Want a Shorter Loan Term

Refinancing from a 30-year to a 15-year mortgage saves massive amounts in interest, but increases your monthly payment.

When This Makes Sense:

• Your income has increased
• You want to pay off debt faster
• You're approaching retirement
• You want to reduce total interest paid

Trade-offs:

• Higher monthly payments
• More money toward mortgage vs. other goals
• Less financial flexibility

4. You Need Cash and Have Equity

A cash-out refinance lets you borrow more than you currently owe and take the difference in cash.

Common Uses:

• Home improvements
• Debt consolidation
• Major expenses
• Investment opportunities

Warning: This increases your debt and monthly payment. Only do this if the cash is used for something that improves your financial situation (like improving home value or consolidating high-interest debt).

5. You Want to Convert an ARM to a Fixed Rate

If you have an adjustable-rate mortgage and want predictable payments, refinancing to a fixed-rate loan makes sense.

When to Do This:

• ARM is about to reset to higher rates
• You want payment stability
• You plan to stay in the home long-term
• Rates for fixed loans are reasonable

When NOT to Refinance

1. You'll Pay More in Closing Costs Than You'll Save

Refinancing has costs similar to your original mortgage:

• Origination fees (0.5-1% of loan amount)
• Appraisal fees ($300-500)
• Title insurance ($500-1,000)
• Recording fees ($50-500)
• Credit check fees ($25-50)
• Attorney fees (if applicable)

Rule of Thumb: Calculate your "breakeven point": Breakeven = Total closing costs / Monthly savings

Example:

• Closing costs: $4,500
• Monthly savings: $150
• Breakeven: 30 months
• Not worth it if you plan to sell in 24 months

Use our Loan Calculator to compare your current loan vs. new loan and calculate if savings exceed costs.

2. You're Close to Paying Off Your Loan

If you're in the final years of your loan, refinancing usually doesn't make sense:

• Most interest has already been paid (in the early years)
• You'd be spreading remaining principal over a new 30-year term
• You'd actually pay more total interest

Example:

• Original $200,000 loan, 22 years in (8 years remaining)
• Remaining balance: ~$50,000
• Refinancing resets to 30 years
• You'd pay interest on $50,000 for 30 years instead of finishing in 8 years

3. Your Loan Amount Is Small

On small loan amounts, the fixed costs of refinancing often don't make sense.

Example:

• Remaining balance: $25,000
• Closing costs: $3,000
• Rate reduction: 1%
• Monthly savings: ~$12
• Breakeven: Over 20 years

Generally not worth it for loans under $50,000-75,000.

4. You Plan to Move Soon

If you plan to sell your home within 2-3 years, refinancing rarely makes sense because you won't recoup closing costs.

5. You'd Reset Your Amortization Schedule

Refinancing restarts your loan's amortization, meaning you'll pay mostly interest again in the early years (like your original loan). This can be costly if you're years into your current loan.

Calculating Refinancing Savings

Step 1: Calculate Current Loan Costs

Use our Loan Calculator with your current:

• Remaining loan amount
• Current interest rate
• Remaining term
• See total payments left

Step 2: Calculate New Loan Costs

Use the calculator with new terms:

• Proposed loan amount
• New interest rate
• New term length
• See total payments

Step 3: Add Refinancing Costs

• Closing costs
• Appraisal fees
• Other fees
• Total refi costs

Step 4: Determine Net Savings

(Current total payments left) - (New total payments + closing costs) = Net Savings

Example Calculation:

• Current situation: $200,000 remaining, 5% rate, 20 years left
• Total remaining: $380,000
• Refinance to: $200,000, 4% rate, 30 years, $5,000 costs
• New total: $343,000 + $5,000 = $348,000
• Savings: $380,000 - $348,000 = $32,000

This is worth refinancing!

Types of Refinancing

Rate and Term Refinance

Best for: Getting a lower rate or changing your term

When it works:

• You can lower your rate significantly
• Rates have dropped 0.5-1%+ since original loan
• You can afford shorter term

What changes:

• Interest rate
• Loan term (optional)
• Monthly payment

Cash-Out Refinance

Best for: Accessing home equity for major expenses

When it works:

• You need cash for improvements or investments
• You have significant equity
• You can afford the higher payment
• Investment return exceeds loan rate

Warning: Increases your debt and monthly payment. Use carefully!

Streamline Refinance

Best for: FHA and VA loans

Benefits:

• Lower credit score requirements
• Reduced documentation
• Lower or waived appraisal
• Faster process

Requirements:

• Current on payments
• Benefit from lower rate
• No cash out (rate/term only)

Mortgage Refinancing Mistakes to Avoid

1. Focusing Only on Monthly Payment: A lower payment over 30 years might cost more than finishing your current 15-year loan.

2. Ignoring Total Interest: See the big picture, not just the monthly savings.

3. Not Shopping Around: Different lenders offer different rates and costs.

4. Refinancing Multiple Times: Multiple refinances can cost more than simply taking the original deal.

5. Using Cash-Out for Lifestyle Inflation: Using equity for vacations or unnecessary purchases increases debt.

6. Forgetting About Prepayment Penalties: Some original loans charge fees for paying early.

Should You Refinance?

Ask yourself these questions:

1. Can I get a significantly better rate (0.5-1% lower)?
2. Will I save more than I'll pay in closing costs?
3. How long will it take to breakeven on closing costs?
4. Do I plan to stay in the home long enough to recoup costs?
5. Can I afford the new monthly payment?
6. Does it improve my financial situation overall?
7. Have I improved my credit score since the original loan?
8. Are my financial goals aligned with refinancing?

Using a Loan Calculator

Our Loan Calculator helps you:

1. Calculate your current loan's remaining costs
2. Calculate the new loan's costs
3. Compare monthly payments
4. Determine total savings (or costs)
5. Calculate your breakeven point
6. Make an informed decision

Always run the numbers before refinancing!

The decision to refinance depends on the numbers, your goals, and your situation. Don't refinance just because rates are low—make sure it makes financial sense for you specifically.