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Refinance 101

Refinance 101

Determining if refinancing your home loan is right for you

Refinancing a mortgage can potentially save a home owner a substantial amount of money over the life of a home loan. However, when considering refinancing, be sure to take into account the upfront costs.

Here are some of the reasons why you may choose to refinance.

Lower Your Monthly Payment

If current interest rates are lower than the rate you are paying on your mortgage, refinancing could lower your monthly payment. For example, if you have $250,000 remaining on your mortgage at 6% for 30 years, your monthly payment (principal and interest) would be $1,499. If you were able to refinance to a 5% loan for 30 years, your monthly payment (principal and interest) would drop to $1,342, a reduction of more than $150 per month. Note that some of the reduction may be due to stretching out your payments rather than reducing your rate. The longer you stay in your house, the more money you can save by refinancing. However, consider that you will have to pay upfront closing costs because you are taking out a new mortgage. Discover’s Mortgage Refinance Calculator can help you determine at what point you will recoup your upfront costs and start reduction from your refinancing.

Tip: Many lenders will tell you that rates must drop by at least 50 basis points (0.50%) for refinancing of the same loan term to make financial sense, but this threshold is different for everybody. The most important factor in your decision should be how long it takes to recoup the costs to refinance. If you expect to remain in your current home beyond the length of time it will take to recoup the costs, then it’s a good idea to consider refinancing your mortgage.

Switch to a Short-term Loan

Depending on your situation, it could make sense to switch from a long-term loan to a short-term loan through a refinance. This might be particularly beneficial to you if you are now able to afford a higher monthly mortgage payment. Switching from a 30-year loan to a 15-year loan results in higher monthly payments but pays the loan off much more quickly, saving thousands of dollars in interest payments over the life of the loan.

Change from an Adjustable-rate to a Fixed-rate Mortgage

Adjustable-rate mortgages (ARMs) are great for minimizing your monthly mortgage payment in the early years of owning a home. But when interest rates start to rise, so do the monthly payments on an ARM. To avoid the increasing payments, you can switch to a fixed-rate mortgage. While the monthly payments on a fixed-rate mortgage may initially be higher than the payment on your ARM, you will have peace of mind knowing your payment will remain the same, even if interest rates continue to rise.

Change from a Fixed-rate to an Adjustable-rate Mortgage

Sometimes it makes sense to switch from a 30-year loan to a one with a shorter term. For example, if you know you will be selling your house in the next few years, switching to an adjustable-rate mortgage could lower your rate and your monthly payment until you sell your house. Another example is when short-term rates are lower than long-term rates, and refinancing into an ARM would save you money at least during the fixed-rate period.

Take Cash Out

When you have equity in your home, cash out refinancing can allow you to turn that equity into cash. You might want to do a cash out refinance if:

  • You want to make a large purchase but do not have access to other funding, or other funding is more expensive than the rate you can get on a refinancing.
  • You can take extra equity from your home to pay off more expensive debt and save money.

Some examples of what you can do with the equity you take out include:

  • Making home improvements
  • Purchasing an investment property
  • Paying for a child’s education
  • Paying off credit cards, medical bills or other higher interest debt

Read our Cash Out Refinance article for more information on this option.

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