When Is It Time To Refinance a Home?

When you refinance, you get a new mortgage to pay off your existing mortgage. At first, this may seem like a bad decision on its face. Getting a new mortgage takes time and money, so why should you want to do it? But there are a few reasons to consider refinancing.

One reason to consider a refinance is if your initial mortgage had a relatively high interest rate, but the rates later went down. By taking advantage of a lower rate, you can get the same size loan for lower monthly payments. The typical advice is that if you can get a rate at least one percentage point lower than your current rate, a refinance is worth your while.

You also need to consider the costs. Mortgages cost money, so a new loan is only worth your while if you would pay less in fees than you would save on the payments. To come up with the break-even point on a mortgage refinance, divide the total loan costs by monthly savings. So if your refinancing fees total $3,000 and you save $100 a month, divide 3,000 by 100 and you get 30. That means it will take 30 months to recoup the cost of refinancing.

When adding up the costs for your break-even calculation, be sure to account for any additional years of interest you'll be paying. If you have 27 years left and you're starting over with a 30-year refi, that's three extra years of interest, meaning your break-even period is longer.

Before refinancing, you might want to check your credit score. The higher the score, the better the interest rate you're likely to get. Bringing cash to closing also might get you a slightly lower interest rate or allow you to avoid private mortgage insurance.

Getting access to cash
Another reason for refinancing is gaining access to home equity. It's sometimes the cheapest way possible to borrow money. But cash-out refinance rates can be a bit higher than rate-and-term refinance rates. Access home equity if you have at least 20% equity remaining after the transaction. If getting cash is the key point of a refi, a home equity loan or line of credit may be less expensive than closing costs on a cash-out refi.

You also may want to go in another direction with your loan. You can refinance to get a shorter loan term — 15 years instead of 30, for example. This will increase your monthly payment, but your interest rate will be lower, meaning you'll pay less interest over time. However, with interest rates low, you may not mind spending more years paying off your mortgage to use the extra cash to invest at a higher rate.

But whatever your reason is for taking a fresh look at your mortgage, it's always wise to determine whether refinancing makes financial sense. Make sure a refi will meet your goals: Does it reduce your mortgage payment? Shorten the term of your loan? Help you build equity more quickly? Will you be living in your house long enough to meet the desired break-even point?
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The above advice is general — your specific situation may vary. Get advice from a financial professional to make sure a refi is in your best interests. And since mortgages come with so many provisions, be sure to get all the details from the mortgage provider before signing on the dotted line.
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