Loan refinancing – replacing existing credit conditions with others secured by the same assets.
Calculator for calculating refinancing conditions and comparing with the current loan conditions online.
How long will it take to break even on a mortgage refinance? That depends on a multitude of factors, including your current interest rate, the new potential rate, closing costs and how long you plan to stay in your home. Use this calculator to sort through the confusion and determine if refinancing your mortgage is a sound financial decision. Click the "View Report" button for a detailed look at your records.
This calculator makes it easy for homeowners to decide if it makes sense to refinance their mortgage to a new loan with a lower interest rate. It calculates how many months it will take for the refinance interest & payment savings to pay for the closing costs of the new loan, along with the monthly loan payments and net interest savings.
With savings in mind, many homeowners rush to refinance their mortgage when market rates are low. A lower rate helps reduce monthly mortgage payments and total interest costs. Because of this, refinancing activity generally increases when mortgage rates fall.
When It Makes Sense To Refinance Your Mortgage
Refinancing is basically replacing your existing mortgage with a new loan. It allows you to obtain better rates and terms. It even lets you change the type of loan and payment structure of your mortgage. But before you apply for refinancing, here a several factors you should carefully assess:
Lower Market Rates
Consider refinancing if you can significantly lower your interest rate. Check current refinance rates to see if they drop low enough to justify refinancing. Financial experts advise lowering your rate by one-half to three-quarters of a percentage point. Rates this low can substantially decrease your monthly mortgage payments.
On the more conservative side, some financial experts recommend lowering your rate by at least 2 percentage points. The lower your mortgage rate, the less time it will take to breakeven on your refinancing costs.
Is It Aligned With Your Financial Goals?
Next, carefully assess your financial situation. Are you currently paying a large interest debt? Can you prioritize refinancing expenses? If you’re tight on funds, refinancing your mortgage is out of the question. To save on interest and slightly shorten your term, you’re better off making small extra payments on your mortgage than refinancing.
On the other hand, new mortgage closing costs typically range between 2% to 5% based on your home’s purchase price. Closing costs for new home purchases require similar documentation. For this reason, it makes sense to refinance with the same lender, because they don’t require all documents to be new for application. Staying with your original lender also gives you higher chances of scoring a favorable rate.
For instance, if your principal is $300,000, a discount point would cost $3,000. Discount points can also be purchased as a half point or quarter point. So if your principal is $300,000, a half point is $1,500, and a quarter point is $750.
Consider how long you intend to stay in your home. If you’re moving within the next two or three years, you won’t have enough time to breakeven on your refinancing costs. You’ll lose money instead of gain savings. You’re better off saving your money to cover your move.
Another factor to consider are early repayment fees. Prepayment penalty is a charge that lenders impose if you refinance, sell your home, or pay off your loan principal before the due date. Expensive penalty fees can cancel any savings you make from refinancing or prepaying your mortgage.
As of January 10, 2014, lenders can only charge prepayment penalty for the first three years of a mortgage. This rule was employed by the Consumer Financial Protection Bureau (CFPB) for most residential loans. However, it does not apply to mortgages purchased before the January 2014 rule. Make sure to check your prepayment penalty clause before prepaying or refinancing your loan.
Do You Have A High Credit Score?
Furthermore, check your credit rating. To qualify for refinancing, your credit score must be at least 620. But even then, it does not guarantee a much lower mortgage rate. To obtain the best rates and terms, you must have an excellent credit score.
Improve your credit rating before applying for refinancing or any new loan. You can increase your credit score by paying bills on time and reducing your debts. Overall, a better credit profile will help you obtain more favorable loan deals in the future.
Make Sure To Have Enough Home Equity
Check how much equity you have on your home. For a conventional loan, you should have at least 20% home equity to be eligible to refinance. That’s a loan-to-value ratio (LTV) requirement of 80 percent or less. This automatically removes private mortgage insurance (PMI) when you refinance your loan. Most mortgage lenders also expect borrowers to keep their mortgage for at least 12 months before they can refinance.
In some cases, other lenders may only require 5% home equity. But keep in mind that low home equity and high LTV ratio results in a higher interest rate. You’ll also end up paying for PMI on your loan.
Why People Choose To Refinance
Most homeowners choose a straight rate and term refinance that reduces their rate and makes their repayment term more manageable. You may choose to shorten your loan to 15-year term. This increases your monthly payment, but it pays off your mortgage early while saving a great deal on interest payments. On the other hand, you may opt to reset your term to 30 years, which lowers your monthly payments. But beware. Extending your term means you’ll pay higher total interest on your loan because of the added years.
Refinancing allows you to change the type of loan you have. If you have a government-backed mortgage such as an FHA loan, you’re required to pay mortgage insurance premium (MIP). MIP is required for the entire life of a 30-year fixed-rate FHA loan. This is a costly added fee that protects lenders in case you default on your mortgage. To eliminate MIP, many homeowners with FHA loans eventually refinance into a conventional loan.
Next, refinancing enables you to shift from an adjustable-rate mortgage (ARM) to a fixed-rate loan and vice versa. Many homeowners with an ARM eventually refinance into a fixed-rate mortgage to lock in a low rate. This ensures their rate remains the same throughout the term. When index rates are high, they don’t have to worry about increasing payments in the future.
Homeowners also have the option to take cash-out refinances. This allows you to borrow money against your home equity while refinancing your mortgage. If you’re looking to fund home renovations or pay for your child’s college tuition, this is a viable option.
The Time It Takes To Refinance Your Loan
Mortgage refinancing typically takes 30 days up to 45 days to close. But this can take more time, depending on market conditions and the type of loan you get. During seasons when more homeowners refinance, the process can take longer.
In August 2020, the Ellie Mae Origination Insight Report showed mortgage refinances took an average of 50 days to close. Across loan types, home loans backed by the Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA) took longer to close than conventional loan refinances.
The report also revealed that loans with lower interest rates had longer average times to process. It shows that refinances took around 15 days longer in August 2020 compared to March 2020 when mortgage rates began decreasing at historic lows.
It’s important to calculate how many months it will take to recoup your refinancing costs. This is called the breakeven point, which is the time you’ll start making real savings from refinancing. Using our calculator on top, let’s estimate how much interest you’ll save and how many months it will take to reach your breakeven point.
Suppose your original mortgage is a 30-year fixed-rate loan that you’ve paid for 10 years. The remaining loan you owe is worth $200,000 with an interest rate of 5% APR. You have 20 years left to pay off your mortgage. Your original monthly payment is $1,319.91.
Now, you plan to refinance into a 15-year fixed term at 3.25% APR. On top of this, you purchased 1 discount point and paid 1 origination point to your lender.
The table below estimates your refinancing cost, interest payments, and the number of months it would take to reach your breakeven point.
Cash-Out Refinancing For Major Expenses
Besides saving on your mortgage, you can take advantage of cash-out refinancing to tap your home equity. It’s a way to refinance your home loan while borrowing money at the same time. Accessing home equity enables you to pay for major costs such as home improvement projects. Others also use it to consolidate high-interest debts into a lower rate, or to pay for their child’s college education.
When you get a cash-out refinance, it replaces your original mortgage with a new loan for more than you owe on your home. The difference is given to you in cash, which you can use to fund important expenses. This option usually has a lower rate compared to taking a second mortgage such as a HELOC or home equity loan.
Since a cash-out refinance has a higher loan amount, it usually has a higher interest rate than your current mortgage. Depending on the type of loan, borrowers can cash out around 80% to 90% of their home’s value.
Tax Incentives
You are eligible for mortgage interest deductions when you refinance your home loan. This tax deduction incentive is given to homeowners to reduce interest payments on their mortgage. But note that it’s only granted if you use the loan to build, purchase, or make home improvements on your property. For example, if you obtained a cash-out refinance to extend your property, you’re eligible for mortgage interest deductions. However, if you use the loan to pay for your child’s college tuition, or to consolidate debt, you won’t get any interest deductions.
Home mortgage interest can be deducted on the first $750,000 of a borrower’s debt. For those married and filing separately, deduction is granted on the first $375,000. If you obtained your mortgage before the Tax Cuts and Jobs Acts of 2017, you can deduct interest on up to $1 million if you’re the head of the household, and $500,000 if you’re married and filing separately. But after 2025, the home mortgage interest deduction limit is expected to revert to $1 million.
Other Ways To Tap Your Home Equity
Apart from cash-out refinancing, you can take a second mortgage to access your home equity. A second mortgage is a lien taken against a house that already has a mortgage. Your lender basically takes a lien against a part of your property that you’ve paid off.
How does a second mortgage work? A second mortgage is a completely different loan from your original mortgage. Lenders let you borrow money against your home equity, then you pay it back with interest. While you’re making payments on your original mortgage, you’re making a separate payment on your second mortgage. Refinancing, on the other hand, replaces your existing mortgage with an entirely new loan. This only requires you to make one mortgage payment every month.
If you fail to repay your mortgage, a second lender only obtains their payment after the original lender gets paid. Because of this, second mortgages typically have higher interest rates than a refinance. The lower rates for refinances are also more appealing to borrowers.
There are two types of second mortgage, a home equity loan, and a home equity line of credit (HELOC).
Home Equity Loan
When you obtain a home equity loan, it’s given to you as a lump sum fund. Borrowers cash out all the money at once and repay it in installments. This option is ideal if you need a definite amount to cover a one-time cost, such as a kitchen renovation or other expensive purchases. Home equity loans may also be used to consolidate high interest debts. You can use this money to fund any large purchase or project as long as you pay back your lender within the agreed terms.
Home equity loans are structured as fixed-rate loans. They come in short 5-year terms, to longer 15-year terms and 30-year terms. The fixed-rate structure lets you pay a predictable amount every month. This way, you don’t need to worry about increasing payments when rates become higher. If you want the stability of fixed loan payments, this is the right option for you. It’s the opposite of HELOCs that come with adjustable rates.
Home Equity Line Of Credit (HELOC)
A HELOC gives borrowers access to revolving credit which works much like a credit card. It allows you to withdraw funds as needed, either through an online transfer, writing a check, or a credit card connected to your account. The flexibility allows you to borrow more money against your home equity. If you’re paying for expenses over an extended period of time, consider this option. You can withdraw money up to a pre-approved limit while paying interest against the amount you borrowed.
HELOCs come with a “draw period” that typically lasts for the first 10 years of the loan. Once the draw period ends, you must begin paying back the loan. Next, HELOCS are structured with adjustable rates. This means when market rates are higher, your payments will also increase. And if rates drop, your payments can be smaller. The unpredictable payments are a tradeoff for its financial flexibility.
To protect borrowers from increasing rates, the law requires HELOCS to have a maximum interest rate cap on the loan. This ensures your payments won’t increase to unmanageable amounts. If you’re planning to get a HELOC, think of how this will affect your finances.
Refinancing is a smart financial move that allows you to obtain more favorable mortgage terms. You can shorten your term and gain significant interest savings if you refinance to a low enough rate. Cash-out refinancing also gives homeowners the option to borrow money against their home equity.
But before you apply for refinancing, you must make sure you’re ready for the costs. First, check if general market rates are low to score a good rate. The credit score requirement to refinance is at least 620. But to obtain the best rate, aim to improve your credit score by paying bills on time and reducing your debts.
Next, make sure you’re staying long-term in a house. If you’re moving within the next two years, you won’t have enough time to break even on refinancing’s closing costs. You can also lower your refinancing rate by purchasing discount points, which is paid as an upfront cost to your lender. A lower rate allows you to recoup the cost of refinancing in a shorter period of time.
Besides cash-out refinancing, homeowners can access home equity by taking a home equity loan or HELOC. Home equity loans come as one-time lump sum cash with a fixed-rate interest. On the other hand, HELOCs allow borrowers to withdraw cash as needed through a revolving line of credit. It comes with an adjustable interest rate, which means your loan payments may increase over time.
Please note this calculator is for straight refinances that do not extract any additional equity.