With interest rates on home mortgages at or near historic lows, now might be a great time to refinance your home loan, assuming you're paying a higher rate than what lenders are now offering. But it's important to take a closer look before deciding whether refinancing makes sense in your situation.

What refinancing involves

When you refinance your primary mortgage, you replace it with a new mortgage that basically pays off the old loan. In some cases, you can include a secondary mortgage (typically a home equity loan or home equity line of credit) in the amount you refinance.

Refinancing requires you to go through a closing process, much like what you went through to get your current loan. There may be up-front costs involved, like closing costs and possibly points. Even so, depending on your situation, refinancing might be cost-effective for you.

A lower interest rate won't necessarily save you money

To figure out the cost-effectiveness of refinancing to a lower interest rate, you need to determine how likely you are to recoup the up-front costs of refinancing. This involves determining your break-even point — the projected time when refinancing will start saving you money, factoring in your current interest rate, the new potential rate, closing costs and how long you plan to stay in your home. You can make such a projection using the Refinance Breakeven calculator on your EY Navigate™ website or mobile app.

Other potential reasons to refinance

Getting a lower interest rate isn't the only potential reason to refinance. Refinancing may also enable you to:

Lower your monthly mortgage payment by extending your payoff period. Let's say you're currently eight years into a 30-year mortgage, and you're having a hard time making ends meet. By refinancing to a new 30-year mortgage, you'd stretch the 22 years of payments remaining on your current loan to 30 years of reduced payments. But remember that you'd also increase your total interest payments over the new life of the loan.

Reduce your loan term. By condensing your loan term (e.g., by refinancing your current mortgage with 25 years of payments left to a new 15-year loan), you may be able to significantly lessen the total amount of interest you'll pay out over the years. The trade-off is that your monthly mortgage payment will probably be higher than what you're currently paying.

Tap your home equity. Maybe you need cash for home remodeling, a financial emergency or to consolidate credit cards or other loans. In a "cash-out" refinancing, you get a mortgage that's larger than what you currently owe on your home, and you receive a check for the difference. Let's say you still owe $90,000 on a $160,000 home and you refinance to a new $110,000 loan. You'll get a check for $20,000 — the difference between the new $110,000 loan and the $90,000 you owe on the old loan less any up-front costs you may have financed. Note that interest on home equity debt that you use for anything other than to build, buy or improve your home is not deductible.

Switch out of an adjustable-rate mortgage (ARM). With an ARM, the interest rate fluctuates based on an indexed rate plus a set margin. Adjustment intervals are predetermined, and there are minimum and maximum rate caps to limit the size of any adjustment in a given year or over the life of the mortgage.

Maybe you'd rather have either a new ARM with better terms or a fixed-rate mortgage in which the monthly interest payment remains the same for the entire loan term. But does it ever make sense to switch from a fixed-rate loan to an ARM? It might be a viable option if you believe that interest rates are headed downward. If, however, you currently have an ARM and believe that interest rates are likely to rise, it may be wise to lock in a lower rate by switching to a fixed-rate loan.

Gain more insights

Your EY financial planner can help you determine whether refinancing might be a good move for you. Call your planner today.

This material is provided solely for educational purposes; it does not take into account any specific individual facts and circumstances. It is not intended, and should not be relied upon, as tax, accounting, or legal advice.