Should You Refinance Your Mortgage Right Now? Here's How to Decide

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Mortgage refinancing activity recently jumped to a two-year high, according to data from the Mortgage Bankers Association. While demand for refinancing is still well below where it was in 2020 and 2021, it is 37% higher than it was a year ago, indicating that many people are finding it worthwhile to refinance their home loans.

With that in mind, here's a quick guide to determining whether refinancing might be a smart option for you, another option you might want to consider, and whether you should hold off until rates fall even further.

Is refinancing right for you?

Before we get into the basic mathematics, it's important to mention that there are two types of mortgage refinancing -- rate-and-term refinancing and cash-out refinancing.

Rate-and-term refinancing

With rate-and-term financing, the math is rather easy. Simply take the cost of refinancing and divide it by the monthly payment reduction you'll get in order to calculate your break-even point. For example, if it costs $5,000 in origination fees and closing costs to refinance and you'll save $200 per month, this shows that you'll break even in 25 months. If you plan to stay in the home significantly longer than that, it could be worth refinancing.

The average 30-year mortgage rate is 6.87% as of the latest data, and many recent home buyers have mortgage rates in the 7%-8% range. So it's fair to say that refinancing is starting to make sense for many people who bought homes in the past couple of years.

More: Check out our picks for the best mortgage lenders

Cash-out refinancing

A cash-out refinancing means you're taking some equity out of your home and getting a mortgage with a larger balance. My general rule of thumb is that the interest rate you can get on a refinancing needs to be at least a half percentage point lower than you currently have. It is rarely a good idea to do a cash-out refinancing with a higher interest rate than your current mortgage. And that's because there could be a better option, as I'll discuss in the next section.

Refinancing vs. HELOC

For many people reading this, the reality is that refinancing doesn't make sense. Millions of homeowners have mortgage rates below 4%, or even 3%, and it likely won't make good financial sense to completely refinance your loan anytime soon.

In situations like this, a home equity line of credit, or HELOC could be a better way to tap into your home equity. To be sure, HELOC interest rates are significantly higher than refinancing mortgage rates. For research, I filled out a HELOC pre-approval form as I'm writing this, and my best rate offer was about 9% -- and variable.

However, think of it this way. Say you need to borrow $30,000 to fund a large purchase and that you want to use your home equity to do it. You owe $400,000 on your home at a 3% interest rate. Borrowing $30,000 at 9%-10% and leaving the $400,000 primary mortgage alone could make a lot of sense.

The bottom line is that HELOC interest rates are likely to be significantly higher than the rates you'll get for simply refinancing your mortgage. But because you can get a HELOC while still keeping your existing mortgage, and because HELOC rates tend to be lower than unsecured personal loans, they can be a solid option to finance a large expense if your mortgage rate is too low for refinancing to make sense.

What if rates continue to fall?

Even if the math makes sense, one of the most common questions I hear from homeowners thinking about refinancing is "what if I refinance and mortgage rates continue to fall?"

The short answer is that it's impossible to predict what mortgage rates will do over any given time period. The unexpected rate spike we saw earlier this year is a perfect example of this. So, don't base your financial decisions on what interest rates might do.

Also, it's important to realize that you can refinance more than once. I know several people who refinanced their mortgages in 2020 when rates started to fall, and then did it again in 2021 when sub-3% mortgage rates appeared. The bottom line is that the important question is whether refinancing makes sense for you now .

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