It can be hard to know when it makes financial sense to refinance your mortgage.
When you refinance your mortgage, you pay off your existing loan by replacing it with a new one. There are many reasons to refinance, including locking a lower interest rate, reducing your loan term, or withdrawing home equity funds.
Decades ago, you couldn’t do loans at truly no cost. CPAs and financial advisors often told their clients it didn’t make sense to refinance for interest rate savings unless the rate was at least a full percentage point lower. More recently, we’ve seen the narrative altered to “only refinance if you save 0.5% or more.”
Here’s why that’s flawed: if you can ever save money at no cost, you should do it at any lower rate. It’s free money. Think of it like being offered a $1 off coupon at the grocery store check-out and saying, “No thanks. If it’s not a $5 savings I’d rather not save at all.” Pretty silly, no?
Here’s a secret for you: our wealthiest clients will refinance if they can save even a nickel at no cost.
Let’s take a closer look at when it’s worth it to refinance your mortgage for a lower interest rate.
At What Rate Is Refinancing Worth It?
In today’s mortgage market, sometimes refinancing your mortgage comes at a cost, and sometimes it doesn’t. When refinancing, you must weigh the cost of the loan, the overall savings, and how much longer you plan to own your home.
Most refinancings are completed to take advantage of lower mortgage rates and reduce your monthly mortgage payment. But in some cases, securing the lowest rate possible doesn’t pay off in the long run.
Why? The simple answer is huge fees usually come with those low rates. Lenders often use very low rates as a marketing tactic to get people in the door and then attach large closing fees (which they don’t disclose in those ads!)
There’s no harm in looking into a low rate you see advertised. But when you learn about the closing fees they come with – sometimes as large as five-figures – you should think long and hard about how long you plan to stay in your home before you sign any paperwork.
In most cases, pick the loan that has closing costs you can pay off in less time than you plan to own your home.
You’re considering a refinance that will save you $100 a month on your mortgage payments and costs $5,000 in closing fees. You plan to stay in your home for at least five more years. Is a refinance worth it?
$5,000 divided by $100 is 50, which means it will take you 50 months before you reach the break-even point on your refinance savings. Since you plan to stay in your home for at least 5 years, or 60 months, refinancing at the lower rate makes financial sense.
Remember, saving any amount puts you financially better off than saving nothing.
On top of this analysis, you should consider current interest rate trends and your own financial future. If interest rates look to be trending downward, you may want to refinance again in several months’ time. And if you have large expenses in the near future, like a home renovation or college tuition, that also should be considered. This is where having a mortgage advisor you trust is crucial; we can guide you through these decisions.
Comparing two loans? Use our mortgage calculator for a quick reality check.
The Benefits of Refinancing
Here are some of the top benefits of refinancing your mortgage:
– Reduce your interest rate
– Lower your monthly payment
– Increase the speed at which you build home equity
– Change your loan structure
– Change your loan term
– Use built-up home equity for debt consolidation, financing a large purchase or business, or paying for a financial emergency
• As an aside: debt consolidation, like paying off credit card debt, can also result in a better credit score
The Bottom Line
When shopping for a mortgage refinance, look first for a lower rate, no-cost loan. If the loan you’re approved for does have some costs, calculate your break-even point to make sure you aren’t spending more than you’ll regain over time.