When to Refinance a Mortgage

Refinancing a mortgage can be a huge cost saver for homeowners. And right now could be a great time to refinance.

For a little recent history, the Federal Reserve had started cutting the federal funds effective rate last year, with signs that the economy was starting to slow down. With the massive economic threats posed by the coronavirus pandemic, the Fed decided to drop rates all the way down to 0.05%. This rate is directly tied to the rate that banks charge their prime customers (aka “the prime rate“), with ~3% added on top. And prime rate is correlated to mortgage rates.

As a result, banks have cut mortgage rates all the way down to all-time historical lows of around 2.75% for 15-year mortgages and 3.33% for 30-year mortgages, respectively. Refinance rates are approximately the same as regular mortgage rates on home purchases. With rates being this low, you could stand to save a lot on interest payments by refinancing at this point in time.

refinance mortgage

Is now a good time to refinance? Generally, yes. But let’s look at the variables.

Mortgage Refinancing Variables

There are a number of variables to consider when determining if and when to refinance your mortgage:

  1. How much longer do you plan to live in the home? The longer, the better, from a refi standpoint.
  2. How secure is your job (which impacts #1)? The more secure, the better, from a refi standpoint.
  3. How is your credit compared to when you originally took out your mortgage? This influences #4.
  4. What is your current mortgage rate, and what refi rate can you get?
  5. 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.

Here’s the calculation:

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 that you predict you will be in your home comfortably exceeds your refinance breakeven – then it is probably a good time to refinance.

The other variable is where refinance rates are at. I cannot see refi rates going much lower than they currently are. However, they could go much higher in the next few years.

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 – these are all good things.

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 you should consider it. You’ll get an even lower rate, and reduce the lifetime interest paid on the loan even further. I’m typically a fan of paying off your mortgage early, but with rates this low, that may not make sense for most homeowners.

Refinancing for the purpose of tapping home equity to then be used for other purposes also defeats the purpose 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.

Refinancing Discussion:

  • 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.

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  1. Gabe

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