Refinancing is the process of replacing an existing debt obligation with a new loan under different terms. Homeowners and borrowers typically refinance to take advantage of falling market interest rates, shorten their loan term, lower their monthly payments, or extract equity from their home (cash-out refinance). To determine if refinancing is a good deal, you must compare your monthly savings against the upfront closing costs.
Refinancing is not free. Lenders charge closing costs (such as loan application fees, appraisal costs, title search fees, and points) which typically range from 2% to 5% of the new loan amount. The break-even point is the number of months required for your monthly payment savings to cover these closing costs: \[Break\text{-}Even\ (Months) = \frac{Total\ Closing\ Costs}{Monthly\ Payment\ Savings}\] If you plan to sell the property before reaching the break-even point, refinancing will cost you more than you save.
To see your current amortized principal and interest schedules, see our amortization calculator or check our general mortgage calculator.
While refinancing to a lower interest rate reduces your monthly payment, you must be careful not to extend your overall repayment period unnecessarily. If you have paid 10 years on a 30-year mortgage and refinance the remaining balance into a new 30-year loan, you will pay interest for a total of 40 years. This could increase your lifetime interest costs even if the rate is lower.
To compare this with other basic financing structures, check our standard loan calculator or try our loan repayment solver.
- Rate-and-Term Refinance: The most common type, where you change the interest rate, the loan length, or both, without taking cash out of the property. - Cash-Out Refinance: You borrow more than you owe on your current mortgage, receiving the difference in cash at closing. This uses your home's equity to fund large expenses like renovations.
To perform basic calculations of these closing cost percentages, check our percentage calculator or check our general interest rate solver.
To qualify for the best refinancing rates, lenders will review your credit score, home equity, and debt-to-income (DTI) ratio. Having at least 20% equity in your home (a loan-to-value ratio of 80% or lower) allows you to avoid paying private mortgage insurance (PMI) on the new loan.
Some lenders offer "no-closing-cost" refinancing. This does not mean the fees are waived; instead, the lender either rolls the closing costs into your new principal balance or charges a slightly higher interest rate to cover the fees.
While mortgages are the most common refinanced loans, you can also refinance auto loans or student loans to lower interest rates and save money, using similar break-even calculations.