Refinancing - When is it a good Idea?
By: Amanda Christensen, Extension Associate Professor
August 25, 2020
When is it a good idea?
Wondering whether it’s a good time to refinance your home mortgage? It costs anywhere from 2% to 5% of your loan’s principal to replace your current home loan with a new one. If you plan to stay in your current home more than a few years, here are the top scenarios when the cost of refinancing may be in your favor:
- Lower your interest rate. This is one of the best reasons to refinance. Financial experts recommend that if you can lower your interest rate by at least 1% it’s probably worth the cost to refinance. Lowering by a full 2% is even better.
- Shorten your loan term. When interest rates fall quite a bit you may have the opportunity to shorten your loan term without much change to your current monthly payment amount. Consider this example from Investopedia: “For a 30-year fixed-rate mortgage on a $100,000 home, refinancing from 9% to 5.5% can cut the term in half to 15 years with only a slight change in the monthly payment from $804.62 to $817.08. However, if you’re already at 5.5% for 30 years ($568), getting, a 3.5% mortgage for 15 years would raise your payment to $715. So do the math and see what works.”
- Convert to a fixed-rate mortgage. If you’ve currently got an adjustable rate mortgage there’s a chance you’ll experience interest rate increases which can make your payment less affordable. If mortgage rates are dropping it’s a good time to consider refinancing to a fixed-rate. When mortgage rates are on the rise however, this may not be a good strategy.
Comparing costs and calculating your break-even point
Common costs associated with refinancing include:
- Bank fees: origination fees, application fees, discount points (if applicable)
- Title costs: title search, title insurance
- Third-party costs: appraisal, attorney fee, credit report, etc.
- Escrow costs: taxes and insurance
To calculate your break-even point, divide your total loan costs by the monthly savings from refinancing to determine how many months if will take to break even. Consider this example from Nerdwallet:
“Let's say the refinancing fees will total $3,000, and you will save $100 a month. Divide $3,000 by $100. The answer is 30. That means it will take 30 months to recoup the cost of refinancing. There’s your break-even point. Everything beyond that 30-month break-even point will be cost savings.”
Not all mortgage lenders are created equally. Compare the costs of refinancing with multiple lenders before you pull the trigger. This helps ensure you get the best bang for your buck.