When to Refinance a Mortgage
Refinancing a mortgage can be a huge cost saver for homeowners.
And right now could still be a great time to refinance.
For a little history, prior to the big 2008 housing crash, the Federal Reserve had started quickly slashing the federal funds effective rate. The rate went from 6.25% all the way down to 0.5%. This rate is directly tied to the rate that banks charge their prime customers (the prime rate), by adding ~3%. Prime rate is directly correlated to mortgage rates. This led to banks cutting 15 and 30 year mortgage rates down to all-time historical lows of around 3% and 4%, respectively.
We’ve since seen a bit of bounce back over the last few months in mortgage rates, but they are still close to historical lows, at about 3.38% (15-year) and 4.48% (30-year). And all else being equal, refinance rates are about the same as regular mortgage rates on home purchases.
So if you had financed your original mortgage prior to or during that great mortgage rate decline that happened during 2007 and 2008, you could stand to save a lot of interest payments by refinancing at this point in time.
Is now a good time to refinance? Generally, yes. But you first have to consider your own situation.
Mortgage Refinancing Variables
There are a number of variables one must consider when determining if and when to refinance:
- how much longer do you plan to live in the home?
- how secure is your job (which impacts #1)?
- how is your credit compared to when you originally took out your mortgage? This influences #4.
- what is your current mortgage rate, and what rate can you refinance at?
- how much are closing costs on refinancing?
From these variables, you can then determine your refinance break-even point, and if you think you will be able to reach it.
Refinance Break-Even Point
A refinance break-even point is how many months it will take you to recoup the costs of the refinance.
To calculate the break-even, divide the total cost of refinancing by the amount you will save on your mortgage payment each month (all else being equal). The resulting number is the length of time, in months, that it will take to break even.
Refinancing costs ÷ monthly savings = refinance break-even point (in months)
You can calculate the monthly savings by using a refinance calculator to compare your current loan to a refinanced loan.
If the length of time you will be in your home foreseeably and comfortably exceeds your refinance breakeven – then it is probably a good time to refinance.
The other variable is where refinance rates are at. Looking historically and at the prime rate, rates could go slightly downward from here, but not much lower. They could, however, go much higher in the next few years.
If you have not refinanced since May 31, 2009, have a mortgage that was financed by Freddie Mac or Fannie Mae, and you have a LTV (loan to value) ratio exceeding 80% – then you may want to take a look at the Home Affordability Refinance Program (HARP) eligibility.
HARP is government program designed to allow those under water (negative equity, or owing more than the loan amount) in their home to refinance without having to pay private mortgage insurance, or PMI.
When NOT to Refinance
There are good reasons to refinance. Namely, if you can cut your interest rate, get locked in to a fixed rate vs. adjustable rate, get rid of PMI, reduce your total interest payments over the life of the loan, or reduce the length of the loan – you get my full blessing.
There are also some bad reasons to refinance.
I am not a big fan of using a refinance to extend the length of a loan in order to reduce monthly payments. In a way, this defeats what should be the true purpose of refinancing – to reduce your total debt and pay it off quicker.
In fact, if you can afford to use a mortgage refinance as an opportunity to move from a 30 year mortgage to a 15 or 10-year mortgage, do it! You’ll get an even lower rate, and reduce the lifetime interest paid on the loan even further.
Refinancing for the purpose of tapping home equity to then be used for other purposes also defeats the true spirit of refinancing. If done in a way that allows you to immediately pay off even higher interest debt, it can make sense. But if done in order to improve your kitchen, take a vacation, or finance more consumer debt – forget it.
- Have you ever refinanced? How much did you save and what refinance rate did you lock in?
- Share your refinancing story, why you did it, and the lessons learned.