When Does A Refinance Make Sense? Don’t Go By the Saving 2% Rule!

When should I refinance?

Refinancing a mortgage when rates are low can save homeowners thousands to tens of thousands of dollars over the life of the loan term.  Too often everyone hears “You shouldn’t refinance unless you can save 2% in rate” and if everyone waited for a 2% reduction, so many could lose out on a very big savings!  Believe it or not, borrowers can even save from only a 1/4% lower interest rate as long as the costs versus savings makes sense.

When does it make sense to lower my mortgage interest rate through a refinance
When does it make sense to lower my mortgage interest rate through a refinance

 Examples to consider when a refinance makes sense or not:

  1. Larger loan amounts do not need as much of a lower rate to make financial sense to refinance.  On larger loan amounts it is easier for lenders to pay for a borrower’s closing costs which could make the loan a low to no cost refinance.  For instance, a lender could price a 1% lender credit on loan amount of $300,000 and could cover $3000 in costs for the borrower, but a 1% lender credit on a $50,000 loan would only be $500 and wouldn’t cover much costs.
  2. Smaller loan amounts will need a larger interest rate reduction to make sense.  A borrower owing $50,000 and maybe has a short term left on their loan amount could actually need more than a 2% savings in rate to warrant a refinance.  When you figure how much the loan must increase on a small loan versus the small monthly savings, it can often make more sense to stay where they are
  3. No cost refinancing with any savings should make sense.  Again, larger loans have the better chance of being a no-cost refinance because a 1 or 2% lender credit can be a large amount on a large loan.  So really any interest savings with no closing costs can make sense because it is just free money.  Technically if you have the opportunity to refinance with a .25% savings every 6 months, that could make sense as long as it is no cost.
  4. Decreasing the term of a mortgage loan can make a huge savings too.  First of all a borrower shouldn’t refinance to a lower term just for that reason because a borrower can always pay extra on their loan to pay it off in a shorter period and realize the savings.  But when a borrower faces the choice of refinancing to a shorter term and can get a lower rate than the longer term option, it can make a lot of sense to choose the shorter term.
  5. Discuss the refinance with your financial advisor to determine which term makes sense for you on a refinance.  Depending on your financial status, your threshold for risk, and your financial plan, you need to discuss which term meets your overall picture best.  For instance, your advisor may want you to keep the longer term loan that has the lower payment so you can invest the savings or you may be one that has the goal of paying off their house early so the short term loan would make more sense then.
  6. Refinancing the mortgage and consolidating debts at the same time can make financial sense.  When you are refinancing, it can make sense to pay off higher interest rate debts with the new mortgage which can save money each month and over time.  The important things to remember when refinancing other debts into your lower rate mortgage are do not obtain the credit card or loan debt again, only consider it if you can’t pay off the debts on your own very shortly, and consider the extra rate or costs of a cash out refinance versus a mortgage that just pays off your first mortgage.  It can also make a lot of sense to combine a 2nd mortgage like a home equity line of credit into a low fixed rate first mortgage.
  7. Seniors can take advantage of refinancing their current mortgage into a Reverse Mortgage so that they can get rid of their current mortgage payment **.  Seniors can realize a huge payment savings in this case and live a more comfortable retirement by using a Reverse Mortgage against the equity in their home.  This can basically make your home equity work for you rather than just sitting there requiring a mortgage payment every month.
  8. If you have a VA, FHA, or USDA loan, take advantage of a streamline refinance often not requiring an appraisal.  All 3 programs offer a lower paperwork, easier path to refinance.
    1. If you have a VA mortgage, learn more about a VA Interest Rate Reduction Refinance Loan (IRRRL) here
    2. If you have a USDA loan, learn more about a USDA Pilot Refinance Loan here
    3. If you have an FHA loan, learn how an FHA streamline refinance works here
  9. Be careful of paying extra points on a refinance loan which makes the refinance costs higher and the break even point longer.  The more costs you incur, the more you owe and the longer it takes for you to break even on your savings.
  10. When refinancing, calculate your break even (actually your loan officer should do this for you but check the math) to see if the cost versus reward makes sense.  Figure the costs on the loan versus the savings and once you know the timeline for realizing a true savings, see if it makes sense.  For instance, if you plan on selling your home in 2 years a break even of 4 years would mean that a refinance doesn’t make sense.  Why pay costs that you won’t make up?

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Lower your rate and payment of your current USDA loan

If you have questions about refinancing your current mortgage, contact our Team Move mortgage experts while rates are low.

** Borrowers must continue to keep the property in good repair, pay taxes and insurance, and occupy the home as a primary residence

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Written By: Russell Smith