Refinancing for a Lower Interest Rate: How Much Can You Save?

Refinancing your mortgage can be a simple way to reduce your interest rate, which can translate to lower monthly payments and ultimately spending less on your mortgage from start to finish.

However, if you're unable to secure a lower mortgage rate, refinancing may not make financial sense—especially since you'll be on the hook for closing costs.

Let’s explore how locking in a lower rate can help you keep more money in your pocket and how much you can save.

When Does Refinancing Make Financial Sense?

Refinancing can generally save you money if you’re able to lock in a better interest rate or mortgage terms than the ones you currently have with your existing mortgage. This can save you money both in the short term and in the long run.

You may want to consider refinancing if:

Interest Rates Are On the Decline

The current interest rate environment matters. Rates typically fall during periods of lower inflation, reduced consumer demand, or when investors seek the safety of bonds during economic uncertainty. Economic slowdowns can also lead to lower rates as lenders compete for fewer borrowers. If you're currently stuck with a higher mortgage rate, consider trading in your current loan while the market interest rates are working in your favor.

Your Credit Score Has Improved

If your credit score was lower when you took out your original mortgage, you may not have qualified for a competitive interest rate—and that may be costing you a lot of money. Reducing your rate by just 0.5% could save you tens of thousands of dollars in total interest in the long run.

Every lender is different, but it’s common for lenders to require a minimum credit score of 620 to refinance a mortgage. The stronger your credit score, the more likely you are to qualify for a lower refinance rate.

You Want To Switch From An ARM To A Fixed-Rate Mortgage

If you have an adjustable-rate mortgage—also referred to as an ARM—your rate can change throughout your loan term—and so can your monthly payment. Refinancing can allow you to transition to a fixed-rate mortgage that will stay the same for the life of the loan. If you do this when rates are on the decline, you could lock in a low rate for the duration of your loan term—and hopefully avoid a higher interest rate that could accompany an ARM.

You Need Access To A Lump Sum Of Cash

Cash-out refinancing can provide much-needed funds that you can use for virtually any reason, from completing home renovations to covering unexpected expenses. Going with a cash-out refinance loan could provide the funding you need at an affordable rate.

How Does Refinancing to a Lower Interest Rate Save Money?

When you refinance your mortgage, you are taking your existing loan and hopefully replacing it with a new loan that has better terms. This can include a lower interest rate, lower monthly payments, or even lower costs over the life of the loan. It all depends on your financial situation and loan terms.

Here are a few ways refinancing your current mortgage can save you money:

Your Monthly Payments Could Go Down

Getting a lower interest rate can reduce your overall loan costs—and that could work out to a lower monthly mortgage payment. Let's say you still owe $250,000 on your original 30-year mortgage and your current interest rate is 7.08%. You decide to refinance and qualify for a 30-year rate of 6.30%. As a result, your monthly mortgage payment (not including taxes and insurance) drops from $1,677 to $1,547. That frees up $130 per month that you could put toward other financial goals.

You Could Pay Less Interest Overall

Let's go back to the example we just used where you lowered your mortgage rate by 0.78 percentage points. In this scenario, your monthly payments wouldn't just go down—you could also theoretically spend thousands less over the life of the loan—especially if you aren’t pursuing a cash-out refinance loan. That's a significant amount of money that you could use for other things.

You May Pay Off Your Mortgage Sooner

When refinancing, you'll have the option to change your loan term to one that’s different from your existing mortgage. That may mean going from a 30-year mortgage to a 15-year mortgage. You can expect a higher monthly payment if you shorten your loan term, but you'll pay less interest overall—and you'll pay off your home loan faster.

How to Calculate Potential Mortgage Savings

Using a refinance calculator can help determine how much money you can save by changing your interest rate, loan term, and loan amount. Remember: A shorter term may result in a higher monthly payment, while a longer term may result in a lower monthly payment, although you may pay more over the life of the loan.

Below is a mortgage calculator you can use to compare your existing loan to a potential refinance option:

Steps to Refinance Your Mortgage

If refinancing sounds like a good option, you can take the following steps:

1. Check Your Credit Score

Your credit health will be one of the most important factors that mortgage lenders consider when determining your refinance eligibility. The stronger your credit score, the more attractive you are as a borrower because your risk of default is lower. Again, you'll likely need a minimum credit score of 620 to refinance.

You can access your credit report for free at AnnualCreditReport.com. The following red flags could be dragging down your credit score:

• A history of late payments
• Past-due accounts
• Inaccuracies or fraudulent activity
• High account balances relative to your credit limits
• Applying for too many accounts

Taking steps to improve your credit before refinancing, like paying off credit cards, can help you qualify for a better mortgage rate.

2. Shop Around for the Best Interest Rates

Every mortgage lender is different, and interest rates can vary from one to the next. It's in your best interest to shop around and compare lenders to find the best rate. Also be sure to compare fees, closing costs and customer reviews from other homebuyers before choosing a lender to refinance. You’ll ultimately want a lender that has experience with refinance loans, or cash-out refinance loans if that’s what you’re looking for.

3. Gather Necessary Documents

Your lender will take a deep dive into your finances before approving you for a refinance loan. Be prepared to provide the following:

• Tax returns and W-2s for the past two years (or 1099s if you're self-employed)
• Recent pay stubs
• Employer contact information
• Two months of bank statements, including investment account statements
• Basic personal information (driver's license, Social Security card, etc.)
• Most recent mortgage statement
• Current homeowners insurance declaration page
• Most recently paid real estate tax bill
• Copy of your mortgage survey plot plan

4. Apply for Refinancing

At this point, you'll complete and submit an application with your lender. Their mortgage underwriting team may come back to you with follow-up questions if they need clarification on anything.

5. Close on Your New Loan

This is when you'll review your new mortgage documents, cover any closing costs, and finalize your refinance loan. If you've taken out a cash-out refinance loan, you can expect to receive those funds soon after.

Key Factors to Consider Before a Mortgage Refinance

Only you can determine if refinancing is worth it. Below are some important things to consider before making a decision:

• Closing costs and fees: These fees can run anywhere from 2% to 6% of the loan amount, and they're typically due at the time of closing. You may have no problem with that if refinancing saves you money in the long run, but it's certainly something to think about. Refinancing closing costs can include a loan application fee, appraisal fee, origination fee, title search and insurance, and other miscellaneous fees.
• Break-even point: This is when your savings start to offset the costs of refinancing. You can divide your closing costs by the amount you'll save on your monthly payments. The result is how many months it will take to reach your break-even point.
• How long you plan to stay in the home: This relates directly to your break-even point. If you discover that it will take years to recoup the cost of refinancing—but you plan on moving before then—it may not make financial sense.
• Whether you need access to funds If you’re seeking a cash-out refi, consider why you may need the money. It might be for something important, like covering a financial emergency or completing a necessary home repair. But if you're looking to fund nonessential spending, the cost of refinancing may not be worth it.

The Bottom Line

Refinancing to a lower interest rate can have financial benefits for years to come. You can expect upfront costs, but that may be a fair trade, especially if you see yourself living in the home long term.

But like anything else, you'll want to do your homework and go with a reputable lender that has the best rates and terms. Your financial health and credit score will be important factors here. If all goes well, refinancing will reduce your interest rate and save you money on your mortgage loan.