For many homeowners the promise of a lower monthly mortgage payment is a huge drawcard. As interest rates go up and down though the question that keeps coming up is: when is it actually the right time to refinance? There's a general rule of thumb that says to wait for a 2% drop in rates - but the truth is this rule of thumb is a bit too simplistic and can sometimes lead to missing out on good refinancing opportunities or putting off making a decision for too long. A more thoughtful and nuanced approach that really considers what's going on in your financial situation is definitely the way to go if you want to make a well informed decision.
The main goal of refinancing a mortgage is usually pretty clear cut: you want to shave a bit off your interest rate so you can lower your monthly payment and pay less interest over the life of the loan. But refinancing does come with costs - and closing costs can be as much as 5% of the value of the property, and include things like fees for the appraisal, title insurance, lender fees and other bits and bobs. Understanding these costs - because they can actually impact how long it takes for the money you save to kick in - is pretty important.
Rather than focusing on how big a drop in interest rates needs to be, take a closer look at your break-even point. That's the time it takes for the small savings you get from your lower monthly payments to add up to the cost of refinancing. For example, if you save $100 per month on your mortgage payment but the costs of refinancing are $3,000, your break even point would be 30 months ($3,000 / $100). If you're planning to stick around in that house for more than 30 months, then the math says refinancing is a good idea. But if you're planning to move sooner, then maybe the costs will outweigh the benefits.
Other than the actual interest rate itself, there are a few other important factors that'll help you figure out the right time to refinance:
- Your Current Mortgage Rate: If your current mortgage rate is super low, then even a big drop in interest rates might not be worth your while - because you're already at a great rate. On the other hand, if you're stuck on a really high interest rate then even a small drop could make a big difference.
- Your Credit Score: If your credit score has improved since you first got your mortgage, you might find you get a much better rate now- even if interest rates generally haven't dropped that much. But on the flip side, if your credit score isn't so hot then you might find you don't qualify for the best rates - which means the savings won't be as great.
- Loan Term: Are you thinking about how long you want your mortgage to be for? Do you want to pay it off sooner to save on interest, or stretch it out to make your monthly payments smaller? Refinancing can let you do either of these things.
- Cash Out Refinancing: Some people use refinancing not just to get a lower rate, but to tap into some of the value in their home to clear up debt, make some home improvements or cover some unexpected expenses. But with a cash out refinance comes the risk that you'll be paying back more money over the life of the loan. So think very carefully about whether this is a good idea for you.
- Future Financial Goals: Think about where you're headed in the next 10 years - your long-term financial plans are key to making any refinancing decision. Can you expect a jump in income? Are you planning on selling your home anytime soon? Your personal circumstances and what you think the future holds should have a big bearing on whether refinancing your mortgage is the right call for you.
Many finance experts reckon that a drop in rates of at least 0.5 - 0.75% is worth considering - if you've got a decent credit score and plan to stick around in your home for a bit. But let's be clear - this is just a rough guideline. The only way to know for sure is to kick the numbers around with a refinance calculator - that way you can compare your current loan against all sorts of new terms, including closing costs.
In the end, whether or not to refinance is all about you - your current mortgage, existing rates, closing costs, credit history and long term financial goals all need to be taken into account. By ditching the arbitrary rules of thumb and getting a clear picture of your financial situation, you can make a decision that really makes sense for your future and your home.
Don't be a one-lender shop when it comes to refinancing your mortgage - rates, fees and terms can vary wildly from one lender to the next. Get some quotes from multiple lenders and you could be looking at some serious savings - even a small difference in the interest rate or closing costs can have a big impact on your long term financial situation.
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