Should you refinance your mortgage or tap into your equity?

Weighing whether you should refinance your home can feel like a big decision—and rightfully so. Your home is likely one of your most valuable assets, and the choices you make about your mortgage can impact your long-term financial health. To make a well-informed decision, it’s important to think carefully about several factors. Here we’ve gathered five essential considerations to help you evaluate whether refinancing makes sense for you.

1. Why do you want to refinance?

Clearly establishing your intentions can help you weigh the potential pros and cons of refinancing. Common reasons for refinancing include:

Want to pay less interest – Capturing a lower interest rate is one of the most popular reasons for homeowners to refinance. For example, if you have a $300,000 30-year loan with an interest rate of 6%, your monthly payment of principal and interest equals $1,799. But with an interest rate of 4%, your monthly payment would be just $1,432—that’s a savings of $367 each month, or more than $4,400 each year.

As interest rates fell in the years following the financial crisis, many homeowners refinanced to save on their payments; however, more recently interest rates have been climbing, which makes it increasingly difficult to refinance into a loan with a lower interest rate.

Average US 30-Year Fixed Rate Mortgage Graph

Convert to a fixed-rate from an adjustable-rate mortgage (ARM) – ARMs have interest rates that can change periodically, whereas fixed-rate mortgages have the same interest rate for the life of the loan. In a rising interest rate environment, like we’re currently experiencing, the interest rate on ARMs will also go up, making monthly payments more expensive. Refinancing from an ARM to a fixed-rate mortgage can eliminate worry about ongoing interest rate increases and surges in your monthly payment.

Pay off your home sooner – If you want to pay down your mortgage sooner, you can refinance into a loan with a shorter term. Shorter loans typically have lower interest rates and paying off your loan sooner decreases your overall interest costs. On the other hand, your monthly payment may be higher as you will pay more in principal each month.

If this is your primary goal, you can also consider keeping your current mortgage and making extra principal payments each month.

Lower your monthly payment – If your budget is tight and you want to reduce your monthly payment, you can extend the term of your mortgage. In this scenario, you’ll free up money in your monthly budget but will end up paying more interest over the life of the loan in addition to covering the costs of refinancing.

Get rid of your mortgage insurance – If your down payment was less than 20% of your home’s purchase price, your lender likely required you to secure mortgage insurance, which could be adding several hundred dollars to your monthly payment. While some lenders automatically cancel your mortgage insurance once your equity exceeds a certain threshold, other lenders may require you to maintain your insurance for a specific period of time, regardless of the equity you have amassed in your home.

If an automatic mortgage insurance cancellation is on the near-term horizon, it might not make sense to pay the costs to refinance. On the other hand, if you’re facing several more years of mortgage insurance, the savings from refinancing into a loan without mortgage insurance may outweigh the costs.

Tap into your home’s equity – It’s important to note that taking equity out of your home means you own less of your home and will pocket less money if you sell the home. You will also be responsible for the costs of the refinancing. If you are in need of cash, there are several ways to access the equity in your home.

2. What are the costs to refinance?

It’s important to note that taking equity out of your home means you own less of your home and will pocket less money if you sell the home. You will also be responsible for the costs of the refinancing. If you are in need of cash, there are several ways to access the equity in your home.

While refinancing fees vary by state and lender, costs typically add up to several thousand dollars. In fact, it’s not unusual to pay 3-6% of the loan amount in fees, according to the Federal Reserve Board. You can expect to pay many of the same fees you paid when you took out your original mortgage, including an application fee, property appraisal fee, loan origination charge, attorney fee, as well as title search and insurance fees. Additionally, your current lender may charge a prepayment penalty for paying off your entire mortgage balance early.

What about “no cost” refinancing?
Some lenders offer “no cost” refinancing products, which allow you to avoid paying up-front fees. But lenders generally recoup the fees by either charging you a higher interest rate or by rolling the fees into the loan amount. In both scenarios, you end up paying the fees over the life of the loan instead of up front.

3. How long do you plan to stay in your home?

If your primary reason for refinancing is to save money, it’s important to consider your break-even point and how that compares to your plans to stay in the home. Your break-even point represents how long it will take you to recover the costs of refinancing and start benefitting from the savings.

For example, if a lower interest rate saves you $200 each month and refinancing costs equal $6,000, your break-even point is 30 months ($6,000 divided by $200). If you plan to move within the next 30 months, refinancing might not make sense.

4. How long have you had your current mortgage?

The longer you have (and pay on) a mortgage, the more your money will apply to the principal, i.e., your equity. If you refinance into a new mortgage with a term that is longer than the remaining term on your current loan, your early payments on the new loan will primarily go toward interest, slowing the equity buildup in your home.

5. Could a different option be a better fit?

If your primary goal is to access the equity in your home, it’s smart to consider all your options. Traditionally, homeowners have been able to borrow against their equity in two ways:

  • A home equity loan, which provides a lump sum of cash that you repay at a fixed interest rate.
  • A home equity line of credit (HELOC), which allows you to draw up to a specific amount and repay those funds over a set period of time at a variable interest rate.

At Figure, we offer a unique home equity line that combines the best of both worlds. Our flexible fixed-rate solution gives you full access to your funds up front and also allows you to make additional draws once you’ve paid down your original loan. Plus, you can get approved in five minutes, funding in five days.2