When Is the Best Time to Refinance Your Mortgage?

When mortgage rates drop like they did in 2020, most homeowners face the same question: Should I refinance? 

The answer could very likely be yes, but—as with all things mortgage—this isn’t a decision you should rush into. In addition to the interest rate, there are other factors you should consider, including how long you’ve been paying your current mortgage and how much equity you’ve built, how long you intend to stick around, and the costs of refinancing.

Reasons to Refinance

There are numerous reasons to consider refinancing, even outside of mortgage rates. You should think about refinancing when: 

Mortgage Rates Fall Below Your Current Loan Rate 

Traditionally, experts have recommended homeowners consider refinancing when interest rates fall one percent below your current loan rate. More recently, that rule of thumb has shifted, and experts now recommend refinancing when rates are just half a percent below your current rate depending on your loan balance. 

That’s because reducing your rate can save you significant cash, both out of pocket each month and over the life of your loan. Plus, a lower rate could help you build equity in your home a lot faster. While the mortgage rate you see advertised might not be exactly right—these rates are constantly shifting—if you can secure a lower rate, it might be worth it. 

You’d Like To Pay off Your Loan Faster With a Shorter Term

In addition to a lower interest rate, a new loan might provide you with an opportunity to get a loan with a shorter term without your monthly payment changing too much. It’s all a matter of math. 

In some cases, a significant drop in interest will make a shorter loan possible, but in other cases, a shorter loan might actually be more expensive. We’d suggest using a mortgage calculator to do the math and see if a shorter-term loan makes financial sense for you. 

You Have Enough Equity in Your Home That You Can Get a Loan Without Mortgage Insurance

Most lenders require homeowners to pay mortgage insurance when they have less than 20 percent equity in their home. (Equity is the difference between what you owe on your loan and how much your home is worth—basically the percentage of your home you’ve paid off.) 

Mortgage insurance is a monthly payment you make that protects your lender if you are unable to pay your mortgage. It can be pretty pricey, so once you have 20 percent equity, it might be worth refinancing. 

You Need Money From a Cash-Out Refinance

If you have a financial emergency or need to make significant repairs to your home, a cash-out refinance could be your saving grace. This type of refinancing allows you to get a new loan for more than you currently owe on your mortgage, giving you extra cash. You may also want to consolidate higher interest or high payment debt into a cash out refinance. 

You can’t do a cash-out refinance for 100 percent of your home’s value, but if you’ve built significant equity, you can refinance for 80 to 90 percent and receive a pretty large amount of money. However, these loans tend to come with higher interest rates, so you should only tap into this option if you really need it. 

Will Refinancing Save You Money? 

There is no hard-and-fast rule regarding the value of refinancing. The process of refinancing can cost you upfront, but in some cases, you’ll quickly make up that expense with the money you save on interest. There are also options for no cost refinances. You may get a higher interest rate, but you can be certain it won’t cost you up-front. In other cases, it might make more sense financially to keep your current mortgage. In order to estimate whether or not your refinance will save or cost you cash, consider the following: 

Estimate the Price of Refinancing

On average, homeowners who decide to refinance spend two to five percent of the loan amount on their closing costs. In addition to closing costs, you’ll also have to pay for an appraisal of your home, credit check, and origination fees. As of December 2020, there is also a new refinancing fee of .5 percent on refinancing loans of $125,000 and higher (except FHA and VA refinances, which are exempt). While customers don’t pay this out of pocket, this fee has make interest rates slightly more expensive. 

Check With Your Current Lender To See if There’s a Penalty for Paying off Your Loan

While Dash home loans does not offer any loans that have a prepayment penalty, other lenders might. Some lenders will charge a mortgage prepayment penalty or early payoff penalty if you pay off your loan early. This fee, typically a percentage of your unpaid principal balance when you pay off your loan, could be significant if you still owe a lot on your original mortgage. 

Consider the Equity You’ve Built

If you have at least 20 percent equity built in your home, you may be able to secure a loan without mortgage insurance. This monthly fee can increase your mortgage payment substantially, so be sure to consider how eliminating it could impact your monthly payment after refinancing. 

Research Your Credit Score 

If your credit score changed since you applied for your first mortgage loan, it might make the terms of your refinanced loan better—or worse. If your credit score has improved, you’ll likely secure a better interest rate on your loan. If, on the other hand, your credit score has dropped, your rate might be higher, even if they’re advertising lower rates. 

If You’ve Had Your Loan for a Long Time, Calculate New Interest Costs

Interest payments on mortgage loans are front-loaded. That means when you have a new loan, you’re paying more towards your interest each month, rather than your principal balance. So if you’ve had your loan for ten years or more, you’re currently paying off principal. If you refinance with a 20 or 30-year mortgage, you’ll go back to paying primarily interest each month. Even if you get a significantly lower rate, it might not be worth it.  

Research Your Potential New Interest Rate

While you’ll see low-interest rates advertised, the rate you qualify for might be slightly different. Talk to a lender to secure a firm interest rate estimate, then crunch the numbers to see how much you’d save each month. 

Use a Mortgage Refinance Calculator

In order to determine whether or not refinancing is worth it, use a mortgage refinance calculator. This will allow you to input real numbers to see how much you’ll save monthly. 

Calculate if Refinancing Is Worth It

There is a “break-even point” at which the savings of a lower interest rate equals the expense of refinancing. After this, you’ll be saving money each month with your new mortgage. For example, if you pay $3,000 in closing costs and your monthly payment decreases by $150, in 20 months you would break even. Use the calculator and all of the information outlined above to determine at what point you’ll break even. 

When calculating your break-even point, it’s also important to think about how long you’ll be in your home. Using the example above, if you plan to move within the next year and a half, you won’t break even on your refinance. If, however, you plan to be in your home for at least five years, you’ll more than make up the cost of refinancing. 

Ultimately, whether or not refinancing is worth it is a question that’s entirely unique to your home, loan, and opportunities. That’s why it’s so important to crunch the numbers to see whether or not it really makes sense for your situation. A mortgage refinance calculator and a dedicated lender like those at Dash can help you solve the complicated refinance equation and make the best decision for you and your family. 

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Opinions expressed are solely my own and do not express the views of my employer.

*When it comes to refinancing your home loan, you can generally reduce your monthly payment amount. However, your total finance charges may be greater over the life of your loan. Your PRMI loan professional will provide you with a comprehensive refinance comparison analysis to determine your total life loan savings.