When Should I Refinance My Home?

Just because you took out a 30-year fixed mortgage when you bought your home, that doesn't mean you have to stick with it forever. You can and should refinance your home if mortgage rates drop, or if you need cheap (these days) money for life events or to pay off debt.

Moving mortgage rates

When mortgage rates fall 1 percentage point below your current fixed rate, you should consider refinancing, which might save you money each month and over the course of your loan.

But when crunching the numbers, also consider extras you might have to pay to get out of your current loan to take out a new one. Some of these add-ons include:

• Points on the new mortgage.
• Closing costs on the new mortgage.
• Early termination fees on the old mortgage.

These upfront costs are mitigated by the money you'll save by reducing the rate. To find out when you'll break even on the new loan, use this formula.

Break-even point = Total closing costs / monthly savings

So if you spend $3,000 in closing costs and save $100 a month on the new rate, you'll need 30 months to break even. If you move and pay off the mortgage in 25 months, you'll lose money on the deal; if you stay for 60 months, refinancing could be a good financial deal.

Remember, you'll pay more money over the long term if you refinance your remaining mortgage for more years than remain on your old loan. If you're, say, 10 years into your old mortgage, taking out a new, 30-year mortgage — even at a lower rate — will cost you money over the long haul. However, that applies only if you plan to stay in the house for the duration of the loan. If you plan to leave sooner, the reduced interest may save you money after all.

Cash-out refinancing

If you've built up substantial equity in your home and you've got high-interest debts to pay, it might be a good idea to tap those home savings in the form of refinancing your mortgage for more than the original loan. That's called cash-out refinancing.

Cash-out refinancing may be a good way to pay for big-ticket items, like a home remodeling or a child's college tuition, at a low interest rate. It's also an acceptable way to consolidate debts, which often has a positive effect on your credit score.

However, cashing out can have some negative consequences too. Instead of paying off credit card debts quickly, you'll pay off the extra money you tapped from your home over the course of the mortgage — 10, 15 or 30 years — which eventually will cost more than high-interest debt. Also, a mortgage is considered "secured" debt; if you can't pay, the bank can take your house. Credit card debt, on the other hand, is unsecured debt; if you don't pay, your credit score will tank, but VISA can't repossess your groceries.

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