When Should You Refinance Your Mortgage

We’ve all heard “The Rule”: If you can lower your interest rate by 2 percent, you should refinance. BUT –  that’s not a great idea. Initially, it may sound like good advice, but let’s take a closer look.

Future Plans

Timing is important. If your near-future plans are to move, it would not be in your best interest to refinance from a higher rate to a lower rate, even if that refinance means saving hundreds of dollars per month on your payment.

Here’s why:

Consider closing costs vs. monthly savings. If you pay for your closing costs (and you will) by either paying out of pocket (cash), or rolling the costs into the new loan, you have “spent” money. Rolling it into the loan means you have increased the amount you owe. Paying out of pocket means taking your cold hard cash.  


If Closing costs = $6,000

And, if monthly savings on your payment = $100

How long will it take you to recoup that $6000:  $6000 divided by $100 = 60 months (5 years) until you break even. After that, you would be saving money – the $100 a month. If you plan to sell inside that  5 year window, you lose money.

If selling and moving is in your future, perhaps switching from a fixed rate to an Adjustable Rate Mortgage (ARM) is in order as it starts at a much lower rate. This can work to your benefit if you plan to sell before the 1st rate-adjustment. Even then, calculate costs vs. savings.

Once you’ve considered your long-term plan, there is one time that a refinance of your mortgage does not make financial sense at all –  If your fixed rate mortgage is due to be paid off in a few years.

On a 30-year fixed rate , for example, each month, the allocation of principal and interest changes although the payment remains the same. With 5 years left on your mortgage, a significantly larger amount of your payment is now going just to principal every month. You’ve already paid most of the interest in the previous 25 years.  In that case, stick it out. Why would you start over, pay closing costs, add years back to the mortgage, just to save that $100 per month. Unless you need the tax write-off, this would never be a sound financial decision. Even if your current mortgage interest rate is at 10% and a new refinance rate of 4%, refinancing may NOT be your best answer.

Good Time to Refinance

There are times when refinancing makes good sense:

  1. You recently bought your home, plan to own it long term, and the interest rate on a new mortgage is lower than what you currently have. (Notice we didn’t say how much lower. Here’s where you need a mortgage professional to help determine real savings value). Using the above example, calculate your “break-even” point. From that point on in your mortgage, you are saving money from the original purchase mortgage. Over the long term, the savings could be tremendous.
  2. You need “cash-out” from the equity in your home to pay off other debts, or make investments, and the interest rate is lower than your current mortgage. If paying off debt is necessary, make sure you don’t increase that debt again.

Always rely on the “Costs vs. savings calculation” in helping you determine real value in refinancing.  Once you do, you can enjoy telling others you “broke the rule”.

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