Should You Refinance Your Mortgage?

Today’s topic comes from Natalie W., who asks a common homeowner question:

“I took out a 30-year mortgage for $773,000 at 7.18% interest to build a new home. But my current home has no mortgage and should bring about $500,000 when I sell it. I’m considering a refinance but am worried about paying too much for closing costs. Should I refinance the new home loan or pay it down with the $500,000 proceeds and send an extra $2,000 monthly?”

Thanks for your question, Natalie! As a homeowner, your mortgage payment is likely your largest monthly expense, making it wise to consider options for reducing it and your overall interest expense. Refinancing is one such option. Let’s review how to determine if a mortgage refinance is the right move for your situation.

Understanding mortgage refinancing

What is a mortgage refinance?

Refinancing is a common transaction in which a borrower takes out a new loan to pay off an existing one. The new debt could be with your same lender or a different institution. The most common reason to refinance is when you can get a lower interest rate, which decreases the interest you must pay and perhaps your monthly payments.

When you take out a mortgage to buy or build a home, various factors determine the interest rate you get offered. While your credit, down payment, and income history are critical, lenders base mortgages on prevailing interest rates, which fluctuate.

The Freddie Mac website shows historical data for interest rates on 30-year mortgages since 1971. In January 2021, a fixed-rate, 30-year mortgage was 2.65% on average. In October 2023, the same loan was 7.8%; in March 2025, the going rate is 6.6%.

Since rates change periodically, your mortgage may significantly differ from the rate you could qualify for today. However, a good rule of thumb is to refinance only when the current rate dips at least one percentage point below what you’re paying.

Navigating the costs of refinancing

Is refinancing worth it? What’s the cost?

As Natalie wisely points out, refinancing comes with costs. It’s essential to be aware that closing costs can be substantial.

Closing a loan involves paying fees to various entities, including your lender or mortgage broker, a property appraiser, a closing agent or attorney, and potentially a surveyor. Additionally, there are government fees for recording the mortgage and other location-specific costs.

The total upfront cost of a refinance can vary depending on the lender and the property’s location, potentially ranging from 3% to 6% of your outstanding loan balance. The key to determining if refinancing is worthwhile is to calculate your breakeven point (BEP) – the time it will take for your savings to offset the closing costs.

If you refinance but don’t keep your home long enough to reach the BEP, you will ultimately lose money. However, if you own the property beyond the BEP, you’ll realize long-term savings by refinancing.

It’s often possible to roll the closing costs into your new loan, meaning little to no upfront out-of-pocket expense. However, be cautious, as this increases the total amount you borrow and may also lead to a higher interest rate over the life of the loan. Always carefully compare your options when considering financing refinance costs.

Calculating Your Refinance Breakeven Point (BEP)

Several factors influence your BEP calculation, including:

Interest rate on your old and new loan
Total closing costs
Your income tax rate
The remaining time you plan to own the property
Any prepayment penalties on your existing loan (if applicable)

However, you can use this simple formula to get a general idea of your BEP:

Refinance breakeven point = Total closing costs / Monthly savings

For example, if your closing costs are $5,000 and your refinance saves you $150 per month on your mortgage payment, your breakeven point would be approximately 33.3 months (or almost three years): $5,000 / $150 = 33.3.

For more detailed calculations tailored to your specific situation, you can utilize online tools like the Refinance Breakeven Calculator at dinkytown.com.

Qualifying for a mortgage refinance

How do I qualify for a mortgage refinance?

Even if refinancing seems financially beneficial, you must also meet the lender’s qualification requirements. While specific underwriting standards vary, most lenders require a minimum amount of equity in your property.

Equity represents the difference between your home’s current market value and the outstanding balance on your mortgage. A¹ crucial metric for refinancing is the loan-to-value ratio (LTV). For instance, if your home is valued at $300,000 and you owe $150,000, your equity is $150,000, resulting in an LTV of 50%. However, if you owed $250,000, your LTV would be approximately 83%.

Typically, you’ll need an LTV of less than 80% to qualify for a mortgage refinance. While some lenders may work with borrowers who have a higher LTV and good credit, they may charge a higher interest rate to compensate for the increased risk.

If you currently have an FHA or VA mortgage, you might be eligible for a “streamlined” refinance program. These programs often involve less paperwork and require less equity compared to a conventional refinance. You can find more information on the FHA Refinance program and the VA Refinance program.

Could you pay off your mortgage early? In episode 857, Laura answers a listener’s question about whether to pay off a mortgage early and how to do it. Listen in the player below.

7 situations where refinancing might be a smart move

Here are seven scenarios where considering a mortgage refinance could be a beneficial financial decision:

You could secure a lower interest rate: As in Natalie’s situation, if you obtained your mortgage when rates were higher than the current market, refinancing could lead to significant savings. However, always carefully analyze the costs and your BEP.
You have an adjustable-rate mortgage (ARM): While ARMs can offer lower initial rates and payments, they come with the risk of increasing payments as interest rates rise. Refinancing to a fixed-rate mortgage can provide payment stability and protect you from potential rate hikes, making budgeting easier.
You don’t plan on moving for several years: Since refinancing involves upfront costs, ensure you intend to stay in your home long enough to pass the BEP and realize the long-term savings. For most homeowners, this typically means owning the home for at least three years after refinancing.
You have sufficient home equity: Generally, you’ll need at least 20% equity to qualify for a refinance. While some lenders may approve refinances with less equity, you’ll likely face higher interest rates unless you have excellent credit. Additionally, if you don’t have 20% equity, lenders typically require private mortgage insurance (PMI), which can negate some of your potential savings and extend your BEP.
Your finances are in good shape: Lenders will assess your income, credit history, and debt levels when considering your refinance application. A strong financial profile will generally result in more favorable refinancing terms. If you’ve recently experienced unemployment or a decline in your credit score, it’s advisable to wait until your financial situation improves before applying. Good credit can translate to substantial savings on mortgage interest.
You need to change a co-borrower: Refinancing can be a solution for removing a co-borrower, such as an ex-spouse or partner, from your mortgage. However, the remaining borrower must independently qualify for the new loan based on their income and creditworthiness. If they don’t meet the requirements, selling the property might be a more viable option.
You want to tap into your home equity: If you have significant equity, a cash-out refinance allows you to borrow more than your existing mortgage balance and receive the difference in cash at closing. This can be used for various purposes, such as home improvements or debt consolidation.

Prepaying your mortgage vs. refinancing

Deciding whether to refinance your mortgage or keep it and make extra payments depends on your individual financial situation and goals. In Natalie’s case, since she is building a new home, it’s reasonable to assume she plans to stay there for several years, which is a key factor in making refinancing worthwhile.

Another aspect to consider is how long you’ve had your current mortgage. Refinancing essentially starts a new loan term from day one. This isn’t necessarily a disadvantage for Natalie with her new construction loan. However, if you were nearing the end of a 30-year mortgage, for example, with only ten years remaining, starting over with another 30-year loan might not yield enough interest savings to justify the costs. With a fixed-rate, amortizing mortgage, the initial years have a higher proportion of interest payments, while later years have more principal payments.

Refinancing isn’t a sensible option when current mortgage rates are too high to generate meaningful savings. Natalie’s current rate is 7.18%, and the prevailing 30-year fixed rate is around 6.6% (as of this podcast recording). Therefore, it’s recommended that Natalie wait to refinance until rates drop by at least one percentage point to 6.18% or lower.

If interest rates don’t fall sufficiently, making extra payments towards her mortgage principal, either as a lump sum or through additional monthly payments, could be a better strategy for Natalie to reduce her long-term interest costs and pay off the loan faster. She retains the flexibility to prepay now and still refinance later if rates become more favorable.

However, prepaying your mortgage is only advisable when your overall financial picture is strong. Natalie didn’t provide details about her retirement savings or other debts. But given her ability to consider an extra $2,000 monthly mortgage payment, we can assume her finances are in good shape.

For a deeper dive into the advantages and disadvantages of paying off your mortgage early, check out Money Girl podcast episodes 836, Should I Invest Extra Money or Pay Down My Mortgage?, and 774, How to Know When to Invest or Prepay Debt.

Key takeaway: Compare lender offers

If you decide that refinancing your mortgage is the right path, be sure to maximize your potential savings by comparing offers from multiple lenders. Interest rates can vary by half a percent or more between lenders, which can translate to a significant difference in your monthly payments and overall long-term savings. In some cases, your current lender might be willing to waive certain fees if services like your title search, survey, or appraisal are relatively recent (within six to twelve months).

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