When (And When Not) to Refinance a Mortgage

FT Contributor  | 

In mid-May of 2020, the average rate on a 30-year fixed mortgage hit 3.09% — a record low. This remarkable event was due, in part, to the pressure created by months of quarantines set in motion by the COVID-19 pandemic.

While the circumstances were unenviable, the record rates attracted many buyers who still had the financial wiggle room to consider refinancing their mortgage.

Reasons to Refinance a Mortgage

Even when alluringly low mortgage rates are on the table, the question still has to be asked: is now really a good time to refinance your mortgage?

It’s a quandary that has always plagued homeowners. Fortunately, if you take the time to do your research and consider your entire situation, you can come up with a fairly solid answer.

To begin, it’s important to consider the various reasons that you might want to refinance your mortgage in the first place. These typically revolve around:

  • Getting a lower interest rate: If interest rates were high when you bought your home, you may want to refinance in order to lock in a lower rate.
  • Extending or shortening the period of a loan: If you want to lower your payment, you can lengthen your loan period, although that usually leads to paying more interest over time. You can also shift from a 30-year to a 15-year loan and pay your home off faster.
  • Shifting from an adjustable-rate to a fixed-rate mortgage: If your interest rate moves over the course of your loan, you can shift to a fixed-rate mortgage in order to freeze things at a desirable rate.
  • Eliminating mortgage insurance: If you own most of your home and you don’t need to pay mortgage insurance anymore, you can refinance to eliminate the added cost.
  • Tapping into your home equity for cash: If you commit to a cash-out refinance, you replace your existing mortgage with a larger one, with the difference between the two going to you directly in cash.

While all of these are legitimate reasons to refinance a mortgage, you still want to be very cautious before doing so. There are quite a few costs involved that must be considered beforehand.

What Is a Good Mortgage Rate?

As previously mentioned, the average mortgage rate hit rock bottom in mid-2020. However, that doesn’t mean you, in particular, would necessarily get that rate, as there are many factors that lenders consider when offering a rate to a customer.

With that said, it’s important to do your research in order to ensure that you’re actually offered a good mortgage rate.

For starters, look up what the current average rate is when you go to refinance. Then, gather quotes from multiple lenders to compare your options. Your credit score will likely be a major factor in what kind of rates you qualify for. If you’re not happy with your current rate options, the solution may be to start improving your credit score before you consider refinancing.

Once you have your various quotes, you can choose which one you want to go with and then compare it to your current mortgage interest rate.

When Is It Smart to Refinance My Home?

The question that still stands is when you should actually refinance your home. Typically the best reasons to seriously consider refinancing are:

  • If the current mortgage rates are significantly lower than your existing rate.
  • You have a legitimate reason from the list outlined above (such as adjusting the length of the loan or utilizing a cash-out refinance.)
  • Your credit score is healthy.
  • You plan to stay in your home for a while still.
  • You’ve run the numbers and the savings are worth the investment (more on that further down).

If enough of these reasons tip in your favor, it may be time to refinance your mortgage.

When Is It Bad to Refinance My Home?

Of course, there are also many scenarios when you should hold off on refinancing your home. For instance, it may be a bad idea if:

  • You just bought the home recently — there are no hard and fast rules, but if your mortgage is young (and the fees to initially set it up are in the recent past) it likely isn’t the time to think about refinancing.
  • You have bad credit and need to boost your score before applying for a rate.
  • You want to move soon and won’t break even on the savings before you move.

If there are legitimate reasons to hesitate about refinancing, it’s important to factor them into your decision.

Should I Refinance My Home?

With so many pros and cons flying around your head, it can be difficult to decide if refinancing is the right choice at the moment. However, at a certain point, you need to make a decision. Here are a few questions to ask yourself to help you come to a verdict:

Do you have a legitimate reason to refinance, such as lowering your monthly payment or saving on interest over the course of your home loan? 

If you answered yes, move on to the next question.

Do you currently have healthy credit?

You will likely need a score above 700 and over 750 is ideal if you want to qualify for the lowest rate possible.

If your credit score is good, start applying for mortgage rate quotes at different lenders. If it’s bad, shift your plans to improving your credit score first, as a healthy score will be better than a lower mortgage interest rate over the long term anyway.

How long will it take for you to break even?

This is likely the deciding factor on whether you should refinance. To calculate the break-even point, you’ll need to estimate the closing costs and other fees. These can vary wildly and typically cost between 3 and 6% of your outstanding principal, along with any application, loan origination, or other fees.

To calculate your break-even point, do the following:

  • Subtract your new payment from your old payment: For instance, $1,200 from $1,000 equals $200 in savings.
  • If you want to be thorough, multiply these savings by one minus your current tax rate: For example, if your tax rate is 0.25, multiply your $200 savings by 0.75, leaving you with an after-tax savings of $150.
  • Divide your refinance costs by your savings: If your refi costs come to $3000, dividing that by $150 would come to 20.

Your total is the number of months it takes to break even. That’s the point where you’ll start benefiting from refinancing your mortgage. If you know you’ll be in your house for more than 20 months, there’s a good chance it’s officially time to refinance.


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