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:

1. 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.
2. 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.”
3. 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.”