When mortgage rates fall, many homeowners refinance their loans. While refinance activity is up dramatically over last year, that doesn’t mean it’s always the best move. Knowing when to refinance your mortgage is the trick.
When it’s a good idea to refinance your mortgage
Generally, if refinancing will save you money, help you build equity and pay off your mortgage faster, it’s a good decision. With rates this low, even people who have fairly new mortgages may be able to benefit from refinancing.
Consider refinancing if you can lower your interest rate by one-half to three-quarters of a percentage point — this can substantially lower your monthly payment.
Make sure your total monthly savings offset the cost of refinancing, however. It may not be a good idea if you plan to move in the next two years, which gives you little time to recoup the cost.
The question of when to refinance is not just about interest rates, either; it’s about your credit being good enough to qualify for the right refinance loan. Mortgage interest rates are determined by market factors, including the yields on long-term Treasury bonds, and the best rates and terms go to those with the best credit.
Your financial goals, how long you plan to stay in your home, how much equity you have in the home and your overall financial condition are important considerations when it comes to refinancing. Ask yourself the right questions.
Is refinancing worth it and how does refinancing work?
There are a variety of ways to refinance your mortgage. Finding the right loan depends on your goals. You may want to switch from an adjustable-rate mortgage to a fixed-rate loan that has a steady monthly payment, or you may want to shorten the term of your loan from a 30-year to a 15-year and save yourself a bundle in interest charges.
A refi is also a way to get rid of private mortgage insurance after you have reached 20 percent equity in your home.
Most homeowners opt for a straight rate-and-term refinance that lowers their interest rate and gives them a comfortable repayment term. Some want a lower monthly payment to free up money for other expenses, such as college tuition or an auto loan.
What is a cash-out mortgage refinance?
Other homeowners go with a cash-out refinance, in which they borrow more than they owe on the home and use the cash to retire credit card debt, pay for home renovations or some other major expense.
Wiping out credit card balances with a lower-interest loan can be a wise move, but if you start racking up card balances again, you’re setting yourself back and increasing your risk. Your mortgage is a debt secured by your home; if you start missing mortgage payments, you could lose your home to foreclosure.
“A borrower should consult with a mortgage professional to determine if their financial needs are best suited for a cash-out refinance vs. other forms of credit,” says Richard Liu, a mortgage consultant for C2 Financial Corp., a San Diego-based mortgage brokerage.
How long does it take to recoup the costs of refinancing?
The interest rate is not the only cost to weigh when you’re considering whether refinancing is worth it. There are costs to close the refi loan, and they can be steep. Expect closing costs to total 2 percent to 5 percent of the principal amount of the loan. If you borrow $200,000 and closing costs are 3 percent of that, you would owe $6,000 at closing.
There’s also a new refinancing fee, effective Dec. 1, which tacks on 0.5 percent of the loan balance to your closing costs if your refi is higher than $125,000. This doesn’t apply to FHA or VA refinances.
Rather than require all that money upfront, many lenders let you roll the closing costs into your principal balance and finance them as part of the loan.
To decide whether a refinance makes sense, calculate how long it will take for the cost of the mortgage refinance to pay for itself. If you plan to sell the house before your break-even point, refinancing might not be worth it.
“If a borrower is refinancing strictly to lower monthly mortgage payments and closing costs are $2,400, the borrower should expect to save at least this amount in interest payments for the duration they plan to have the loan,” says Liu.
To determine your break-even point, divide the total closing costs by the amount you save each month with your new payment.
How to calculate your break-even point for closing costs
Let’s say your new mortgage saves you $192 a month and closing costs are $3,000.
$3,000 / $192 a month in savings = 15.6 months to break even
If you plan to sell the house before you break even, refinancing is not a good strategy.
Example of a mortgage refinance
Let’s say you took out a 30-year mortgage for $150,000 at a fixed interest rate of 6 percent. Your monthly payment is $899 and over the life of the loan, you’d pay $323,755, including $173,755 in interest.
Five years into the loan, you’ve paid $10,418 toward the principal and $43,541 in interest. Now you want to refinance the remaining $139,581 of your principal balance with a new 30-year fixed-rate loan of 4.5 percent. Using Bankrate’s mortgage refinance calculator, you can figure out whether this would be a money-saving move.
Your new loan would slash your monthly mortgage payment by $192 a month — to $707. Over the life of the loan, you’d pay $254,605, of which $115,024 would be interest. Add in the $53,959 in principal and interest you paid in five years on the previous mortgage and your total cost will be $308,564 — including $158,565 in interest.
By refinancing, you not only lower your monthly payments significantly; you see a long-term savings of $15,190 in interest.
How long does it take to refinance a mortgage?
The time it takes to refinance depends on your lender as well as how long it takes to complete inspections, appraisals, credit checks and other requirements. Many lenders’ websites allow you to read about different loan products, compare interest rates, fill out loan applications and submit documents.
“Within the past few years, technology has streamlined the mortgage process tremendously,” says Liu. “With online applications, mobile document-scanning apps and e-signatures, borrowers can perform most tasks without printing a single document. Most refinances can be closed within 30 days.”
Use Bankrate’s mortgage calculator to compare your own loan scenarios:
- See what happens when you input different mortgage terms (in years or months).
- Reveal the amortization schedule to see how much total interest you would pay.
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