Why should I refinance my mortgage?

Mortgage debt is a long-term financial commitment, but you should always watch market conditions. As interest rates change and your financial goals evolve, it pays to keep an eye out for something better. Here are several sound reasons for refinancing into a new mortgage with different terms.

To lower your monthly mortgage payment

The most common reason for refinancing a mortgage is to take advantage of a drop in interest rates. This positions you to slash your interest expense and breathe easier with a lower monthly payment.

An old rule of thumb suggests refinancing if the interest rate on your new mortgage is 2% lower than your current one. But you may benefit from smaller differences if the new mortgage has below-average closing costs.

To cover the appraisal, title search, points, origination fee and other costs of your new mortgage, expect to pay fees equal to 3% to 6% of the loan amount. Before refinancing for a lower rate, be confident that you're going to stay in the home long enough to recover those costs.

To figure out your break-even period, divide the closing costs by your monthly savings. For example, let's say your new monthly payment will be $200 lower. If your closing costs are $8,000, it will take you 40 months to break even ($8,000 divided by $200). In that situation, if you think you'll be moving in three years, it could make sense to keep your current mortgage.

Be advised if you're well into your existing mortgage: refinancing could end up costing you more money in the long run, even if your new payment is lower. That's because as you progress in the repayment schedule, greater proportions of your monthly payments go toward paying down principal rather than interest.

If you were 10 years into a 30-year mortgage and refinance into a new 30-year mortgage, you're restarting that principal-interest clock. You could end up shelling out more interest over the life of the new loan than you would if you had stayed in the old one. If you don't plan to stay in your current home that long, it may not matter. But if you do, you should crunch the numbers.

First, figure out how many payments you have left on your current mortgage. Multiply that by the amount of your payment that's principal and interest — not taxes and insurance. Then do the same math for the new mortgage and compare your total costs. Also, consider your other long-term goals, such as retirement, and whether you still want to be paying on that mortgage 30 years from now.

To switch mortgage loan types

You could save money by changing the type of mortgage loan. Not all mortgages are structured the same. For example, if you have a Federal Housing Administration (FHA) loan, you pay a mortgage insurance premium (MIP) for the life of the loan. If you have at least 20% equity in the home, you could refinance from an FHA to a conventional loan to eliminate the MIP. FHA loans can also have higher interest rates. Your payment may still be lower in a conventional loan versus an FHA loan even if you don't have 20% equity. It is important to know factors to consider when comparing different types of mortgage loans.

To switch from an adjustable-rate to fixed-rate mortgage — or vice versa

Adjustable-rate mortgages (ARMs) can offer lower initial rates and payments than a fixed-rate mortgage. That's why they're a popular choice among new homebuyers.

The downside is the possibility that the payment could rise over time when the adjustable-rate resets. If you have an ARM but want the peace of mind of a payment that locks in today's prevailing interest rates, you can refinance into a fixed-rate mortgage.

Of course, you can also move from a fixed-rate mortgage into an ARM. That could be a risky move, though. The ARM interest rate could increase over time. The longer you plan to stay in your home, the more opportunity there is for that rate to rise.

To shorten the mortgage loan term

For many, achieving a true sense of financial security happens when they're debt free. That makes paying off a mortgage a big priority. If you started off with a 30-year mortgage, you may want to refinance into one with a shorter term, such as 15 or 20 years. This can also help if you're several years into your current mortgage but want to take advantage of lower rates without extending your term.

All things being equal, a shorter term means higher payments. But if rates have dropped since you bought your home, you may find there isn't that big a difference.

Keep in mind, you don't have to refinance to shorten your payoff period. By making additional payments of principal — either each month or when you get windfalls such as an annual bonus — you can put yourself well ahead of schedule without incurring the costs of refinancing. Just check with your lender to ensure your current mortgage doesn't have a prepayment penalty.

To cash out some equity in your home

If your home's appraised value is greater than how much you owe on your mortgage, you have equity in your home. To determine how much equity you have in your home, you will need to do a little research to find out what your home is worth.

You could borrow against your home equity with a cash-out refinance. A larger mortgage puts cash in your pocket. You can use this cash for goals like paying off other higher-interest debts.

In addition to taking advantage of the lower rate, you could also benefit from the federal income tax deduction that's generally given for mortgages but not for credit cards or auto loans. Be sure to consult your tax advisor.

Be careful with a cash-out refinance. If you run up higher-rate debts like credit cards again, you could end up with lower equity in your home on top of the debt. Be sure to address any spending or budgeting habits that caused the debt in the first place.

To take advantage of improved credit

If your credit score has seen a substantial increase since you signed your mortgage, you may qualify for a lower rate, even if market interest rates haven't moved. Check with your lender to see if you can qualify for better mortgage terms or a different product with your improved credit score.

The USAA Advice Center provides general advice, tools and resources to guide your journey. Content may mention products, features or services that USAA Federal Savings Bank does not offer. The information contained is provided for informational purposes only and is not intended to represent any endorsement, expressed or implied, by USAA or any affiliates. All information provided is subject to change without notice.