If interest rates dive, your current loan may suddenly become more expensive than a new loan with a lower rate.

You may just want to lower your monthly payment or tap some of the equity you’ve built up. Or you may want to change loans altogether, switching from a 30-year to a 15-year loan term or from an adjustable to a fixed interest rate. Even if you don’t think you’re ready to refinance now, it doesn’t hurt to check your numbers and look at current loan rates. The lower your new interest rate, the less it will cost you to refinance, and the longer you plan to hold your new loan, the more likely it is that you’ll save significantly in the long run.

To recoup the cost of refinancing and achieve real savings, you need a realistic estimate of how long you’ll stay in your house. Consider all possibilities, such as whether your job could change or if you could be transferred. Then do the math. On a 30-year, $120,000 loan at 7 percent, you could save about $20 a month for every quarter-point reduction in interest. If your new rate is 1.5 percent less than what you currently pay, that could mean saving as much as $120 a month, or $43,200 over the life of your loan. You may only plan to stay in your house five years, though, which means you would save only $7,200. If it costs you $3,000 to refinance your loan, your total savings then drops to $4,200. If you stay in the house only three years, you save even less. Assess your time frame realistically. It will help you know whether refinancing is for you, and also help you choose the right loan.

When you refinance, you essentially reset the clock on paying for your house. Refinancing can be an effective savings tool if you want to trim your monthly payment or cut the overall interest you pay on your loan, especially if you match your new loan to the amount of time you plan to keep your house. For example, if you keep your house a long time, refinancing from an adjustable-rate loan to a fixed-rate loan could save you significantly over the long run. If your current monthly payment is comfortable and you plan to keep the house a while, refinancing from a 30-year loan to a 15-year loan could cut your overall interest payments and build your equity faster. The tradeoff is this: while the rate will be around 0.25 percent lower on a 15-year loan, the payment (figured on a shorter term) will be about one-third larger. On the other hand, if you stay in your house only three to five years, you may want to look at adjustable-rate or balloon-payment loans so you can take advantage of the even lower rates these loans carry in the early part of their terms.

Compare both short-term (or up-front) and long-term costs for loans of equal amounts to make a fair comparison. Short-term costs include points and closing costs you’ll pay. (Your lender is required to provide a written estimate of settlement costs with a refinanced loan, just as with a home purchase loan.) The long-term cost is the total interest on the loan. To compare total interest, get an amortization chart from your lender or ask your loan agent to help you. An amortization chart breaks down each monthly payment into interest and principal amounts for any interest rate. For example, if you plan to hold your loan for five years, total the interest for the first 60 payments on various loans you’re considering. Then add the short-term costs for each option. Compare the results with your current loan. Alternatively, have your lender give you a modified Annual Percentage Rate (APR)–which wraps both of these costs into one figure–for each loan you are considering. This tells you which loan option will cost you the least, apart from differences in timing of interest costs versus up-front costs, which could be significant.

To Refinance or Not to Refinance?

One way to compare is to weigh interest rates, closing costs and total interest accrued against the length of time you think you’ll hold the loan. In the example below, a new 30-year, fixed-rate loan (at 6.875 percent interest with two points) offers greater savings than the existing loan or a new loan with no points. However, the savings in total payments or total interest alone come to little more than $1,100 on both refinanced loans if you hold the new loan only five years.