How to Determine the Right Time to Refinance Your Mortgage


Mortgage Recasting vs. Refinancing: Which Is Better? - Experian

One of the biggest decisions homeowners face is knowing when to refinance their mortgage. It can be tempting with all the advertisements promising lower interest rates and cheaper mortgage payments, but refinancing isn’t always the best choice for everyone.

You might have heard the general rule to refinance when interest rates drop by a full point, but it’s not that straightforward. Refinancing a mortgage, much like buying a new house, requires careful consideration and homework.

Every borrower has a unique situation and budget, and just because rates have dropped by a full point or more doesn’t necessarily mean refinancing is the right move for you.

So, when should you refinance your mortgage? Let’s explore the factors you need to consider and the questions you need to ask yourself to make an informed decision.

What Are Your Plans?

First, consider your plans for your home. Do you plan on living in it for another 3 years? 10 years? Forever? This is crucial because if you don’t plan on staying in your home for many more years, refinancing might not make sense.

While you can’t predict the future, try to envision where you’ll be in a few years. For instance, if you currently own a one-bedroom condo but plan on starting a family and moving to a larger house, you might want to think twice before refinancing. Consider your long-term plans before adding a few thousand dollars in extra closing costs just to save a few dollars each month right now.

Why Do You Want to Refinance?

There are various reasons you might consider refinancing:

  • Do you want to cash out some equity to consolidate other debt?
  • Do you want to make renovations or build an addition to your home?
  • Do you want a better interest rate with a smaller payment?
  • Or do you want a shorter term with a larger payment to pay off your mortgage faster?

Ensure you have a good reason for refinancing before signing the loan papers. Some borrowers lengthen their term (from 15 years to 30 years) to get a smaller payment, while others shorten their term for higher payments but a faster route to being mortgage-free. If your goal is to pay off your home faster, or to get a lower interest rate, sometimes it might make more sense to keep your current mortgage and pay extra on the principal.

What Kind of Mortgage Do You Currently Have?

The type of mortgage you have will influence whether refinancing is a good idea.

  • Fixed Rate Mortgage: If you bought your home when rates were historically low and plan to stay there long-term, consider if refinancing will save you money.
  • Adjustable Rate Mortgage (ARM) or Balloon Note: You should check if refinancing makes sense, especially if you might be required to refinance (balloon notes).
  • Prepayment Penalty: Check if your mortgage has a prepayment penalty, which could be a deal-breaker.

Weigh Your Options

If your goal is to get a better rate to pay off your house faster, see if you can pay extra towards your principal instead, especially if interest rates are only a point or two lower than what you currently have. This option can make sense when you don’t have many years left on your mortgage or simply want a shorter term.

If you have room in your budget to pay a little extra each month, you can save significantly on interest over the life of your loan without incurring additional closing costs from refinancing.

The Downside of Refinancing

Refinancing adds additional closing costs to your loan amount. For instance, if you owe $100,000 on your mortgage and roll in $3,000 in closing costs, your new loan amount would be $103,000. These fees are substantial and will affect you in the long run because you’ll eventually pay for them when your mortgage is paid off or when you sell your home. Consider how long it will take you to recoup these fees in monthly savings—your break-even point—before refinancing.

When Is the Break-Even Point?

Determine how long it will take to recoup your closing costs and reach the break-even point. For example, if your old mortgage payment is $1,000 and your new payment is $900, but you rolled $3,000 in closing costs into the new loan, you’ll save $100 per month. It will take 30 months, or 2.5 years, to break even. If you sell your home before that, you’ll have lost money.

Can You Refinance?

Before applying for a refinance, consider if you’ll even qualify for a new mortgage. Have you maintained steady employment and shown you can pay your bills on time? Is your credit score in good shape? Will your home pass an appraisal inspection?

Having an existing mortgage doesn’t guarantee you’ll qualify for a refinance. Banks still scrutinize the condition of your property and your credit and income history. The interest rate you qualify for depends mainly on your credit score and the loan-to-value (LTV) of your home.

Will Your Home Appraise?

Have a general idea of your home’s value before attempting to refinance. Research comparable home sales in your area over the past six months. The homes should be similar in size, condition, style, and acreage. This knowledge can prevent unpleasant surprises during the appraisal process.

When the appraiser visits, provide a list of improvements you’ve made but don’t be surprised if you don’t get the added value you expected. Make necessary repairs before the appraisal to avoid having to pay for a second appraisal.

Loan-to-Value Ratio

Your LTV ratio is the percentage of the appraised value that you want to borrow on your home. This ratio affects the interest rate you qualify for and whether your new loan will require mortgage insurance (MI). If your LTV is over 80%, MI will be required, adding an additional cost to consider.

Refinancing involves many important factors. If you’re still unsure whether it’s the right time, seek recommendations from friends or family for a reputable mortgage broker. They can help you evaluate your situation and determine if refinancing is a wise choice.

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