When to refinance your mortgage: How to know when the time is right

There are many potential benefits to refinancing your mortgage. You can lower your interest rate, reduce your monthly payments, or even tap into your home’s equity if you need to. But there’s one big question — when’s the right time for a refi?

The answer is different for every homeowner. That’s because there are a number of factors to consider, from your credit score to potential closing costs. So, when should you think about refinancing your mortgage?

Here are a few signs it might be the right time for you to refinance:

You can take advantage of a lower interest rate

One of the main reasons homeowners refinance is to secure a lower interest rate. Mortgage interest rates fluctuate over time. If rates have been on a downward trend, it might be a good time to refinance.

A good rule of thumb is that a refi should reduce your interest rate by at least 2%. But even a 1% drop can make a big impact on your payments.

For example: Let’s assume your original mortgage is $200,000 with a 30-year term and a 6.5% interest rate. After five years, you refinance at a 5.5% interest rate. You’d save about $201 a month on your mortgage payments — that’s potentially $74,397 saved in interest over the life of your loan.

You’d like to switch to a different type of mortgage

When you first bought your home, you probably chose between an adjustable rate mortgage and a fixed rate mortgage.

And while your choice might have been the right one for you at the time, you’re not locked into your decision forever. A refinance can help you change to a different type of mortgage agreement if the one you have isn’t the right fit anymore.

For example: You initially closed on an adjustable rate mortgage, so your interest rate fluctuates. If it looks like mortgage rates will be rising in the future, or if you prefer the security of a set interest rate, you might want to switch to a fixed rate option. That way, you can lock in your rate and not have to worry about your interest payments fluctuating each month.

You’d like to stop paying for private mortgage insurance (PMI)

If you didn’t put 20% or more toward your down payment when you bought your home, you’re likely paying for PMI right now. And if that’s the case, you might be able to put a stop to those payments by refinancing your mortgage.

If your mortgage balance is below 80% of your current home value, you can refinance to get rid of PMI. This typically happens in two ways — either your home value went up or you’ve paid off a good chunk of your mortgage. To find out your options for dropping your PMI, you can talk to your lender.

You can afford the refi-related expenses

Just like buying a home the first time around, refinancing usually comes with closing costs. This includes a range of fees, including an application fee, appraisal and inspection fees, title fees, and prepayment penalties.

How much can you expect to pay in refinancing fees? About 2% to 5% of your home’s principal. The average refinance closing cost in the U.S. is $5,779, according to data from financial tech company ClosingCorp.

Keep in mind that your exact amount depends on where you live. Fees vary significantly state to state — they can be as high as $25,000 in Washington D.C. and as low as $2,430 in Wyoming.

These costs can impact how much you stand to save with a refi. First, make sure you have enough cash on hand to cover all the costs. Then, do your research and crunch the numbers to make sure a refinance is worth it.

Tip: Use our refinancing costs calculator to get an estimate of how much you might pay to refinance your mortgage.

You want to consolidate your debt

Have a mortgage plus one or more other loans? You can refinance to consolidate your debts into one easy loan. With a refi, you can merge a primary mortgage and home equity loan into a single fixed-rate mortgage.

This means you’ll only have to manage one streamlined payment each month. Plus, you might be able to convert high-interest debt (like credit card debt) to a lower interest loan by leveraging the equity you’ve built up in your home, helping you save money in the long run.

You're in good financial standing

If you want to refinance your mortgage, your lender will want to know you’re on solid financial ground. They’ll look at your credit score, your debt-to-income ratio and more to determine whether you’re eligible for a refi.

First, your credit score. You can check your score with TransUnion, Equifax and Experian . You’ll likely need a credit score of at least 620 to qualify for a refi and the higher your score the better, according to Experian.

Another consideration is your debt-to-income ratio. It measures how much of your monthly income goes toward paying your debts (credit cards, loans, etc.). It may sound complicated, but it’s actually pretty straightforward. The lower your ratio, the better — lenders like to see a debt ratio below 36% of your gross income.

If your financial situation has improved lately, it might be a good time to look into a refi. You might be eligible for better terms than when you first signed your mortgage.

For instance, let’s say you’ve gotten serious about paying off your debt and now you’ve bumped up your credit score. A higher score might land you a better interest rate, helping you save money on your mortgage over the long term.

The bottom line

Refinancing your mortgage is a big decision, and it’s important to get the timing right. You’ll want to consider the details of your current mortgage, any change in interest rates, and your own financial situation. But if the time is right, refinancing your mortgage can be a game changer. You might get rid of mortgage insurance, consolidate your debt, shorten your mortgage term and potentially save thousands of dollars with a lower interest rate.