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Refinancing Your Mortgage: When and How

Refinancing is essentially taking out a new mortgage to replace the old one. Whether it makes sense, and how much you'll actually save, depends on the math more than the headline rate.

Who benefits from refinancing

A common rule of thumb is that refinancing is worth considering when your current rate is at least two percentage points above prevailing market rates, though every situation is different; a large loan balance can make a smaller rate gap worthwhile, and zero-point, low-cost refinancing offers can shift the math further. Refinancing tends to make sense if you want out of a high rate (and plan to stay in the home long enough to justify the fees), want to convert an ARM to a fixed rate for payment certainty, want a shorter term to build equity faster, or want to draw on your home's equity for a major expense. Most experts estimate it takes about three years to recoup refinancing costs through the lower rate, so a shorter expected time in the home cuts against refinancing.

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How to make the decision

Get quotes from several lenders, compare the APR (which captures rate, points, and fees together, not just the rate), and estimate your break-even point by dividing your total closing costs by the monthly savings. If you currently have an ARM, also ask whether your next scheduled adjustment is likely to raise your payment substantially, and whether your current payment cap (if any) is large enough to actually pay off the loan by the end of its term.

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What refinancing actually costs

Plan on 3 to 6 percent of your outstanding principal in refinancing costs, on top of any prepayment penalty on your existing loan. Typical fees include an application fee ($75 to $300), appraisal ($300 to $700), title search and insurance ($700 to $900), attorney's review fees ($500 to $1,000), loan origination (1 to 2 percent of the loan), and points (1 to 3 percent, where one point equals one percent of the loan amount). It's worth asking your current lender whether any of these can be waived, particularly title, survey, and inspection work that may still be current from your original closing. Prepayment penalties, where they exist, vary by state and loan type; several loan categories, including FHA, VA, and federal credit union loans, prohibit them outright.

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How refinancing affects your taxes

A lower rate means less mortgage interest to deduct, which can offset some of your savings depending on your tax situation. Points paid to refinance generally must be deducted over the life of the new loan rather than all at once, the exception being when some or all of the refinancing proceeds go toward home improvements, which may allow those points to be deducted immediately. If you're also considering a shorter loan term, like a 15-year fixed, weigh the faster equity build and lower total interest against the reduced deduction and higher monthly payment.

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Five tips for getting the best deal

1. Shop around. Call multiple lenders and compare APRs, not just rates, since APR captures points and fees together. You aren't obligated to refinance with your current lender, though some offer loyalty discounts to keep your business.

2. Get a lock-in in writing. A written rate lock protects you from cost increases while your application is processed.

3. Review your disclosure statement carefully. Lenders must provide a written statement of costs and terms under the Truth in Lending Act before you're legally obligated; check the APR, finance charge, and payment schedule against what you were quoted.

4. Know your right to rescind. If you refinance with a new lender, or borrow beyond your current unpaid balance, you generally have three business days after closing to cancel.

5. Ask if the application fee is refundable. Fees typically run $75 to $300 and aren't always refunded if you're denied or withdraw, so it's worth asking upfront.

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Frequently asked questions

Is there a rule of thumb for when refinancing makes sense?

A common guideline is a rate gap of at least two percentage points versus current market rates, though this varies by loan size and how long you plan to stay in the home. Low- or no-point offers can make smaller gaps worthwhile too.

How long does it take to recoup refinancing costs?

Most estimates suggest around three years, calculated by dividing your total closing costs by your monthly savings. If you plan to move sooner than that, refinancing may not pay off.

Are refinancing points fully deductible in the year I refinance?

Generally no; points must be deducted over the life of the new loan. An exception applies when some or all of the loan proceeds are used for home improvements.

This guide is for general informational purposes only and is not tax, legal, financial, or investment advice. Every business situation is different, so consult a licensed professional before making decisions based on this content.