When to Refinance a Home Mortgage

Interest rates down? What to look into before deciding to refinance your home mortgage.

Some people never think about their mortgage after getting it, except to write a monthly check and claim the tax deductions. Others watch the mortgage interest rates like hawks and refinance every time rates dip. The safest course is somewhere in the middle.

Done wisely, refinancing can be one of those, “Whoa, I just earned tens of thousands of dollars for a few hours of work!” tasks. But done blindly—without paying attention to the fact that every new mortgage costs upfront fees and possibly points, and stretches your loan back to a full 30 (or however many) years of interest payments—refinancing can actually cause you to lose money.

Best Time to Refinance a Home Mortgage

For fixed-rate mortgages, the ideal time to refinance is obviously when interest rates are dropping, but by how far? It depends in part on what you'll owe in closing costs, which can run high enough to undo the benefits of refinancing. Be sure to run the numbers, as described below.

Another good time to refinance is if you are tired of the fluctuations in your adjustable-rate mortgage and want to switch to either another ARM with better terms or to a fixed-rate mortgage.

In any case, you will need to take two important steps:

  • find out how much a refinance will cost you up front, and
  • calculate your total savings over time.

As with your original mortgage, you should shop around, checking in with both with your current mortgage company and by comparing rates online and with local lenders. A good mortgage broker can help, too.

Reducing Up-Front Refinance Costs

Just like when you bought the house, refinancing comes with transaction costs. You’ll recognize many of them, such as title insurance and escrow fees, lender service fees, points (if you choose to pay them in return for a reduced interest rate), appraisal fees, credit reporting fees, and so on. Why do you have to pay them all over again?

The main reason is that your new lender wants to assure itself that if you don’t make your mortgage payments, it can sell your house for enough money to cover what you still owe on your loan (the outstanding balance).

Ask your prospective lender or mortgage brokers how to keep these costs down. Some lenders skip the appraisal if you bought the house fairly recently or you have so much equity in the property that the lender is all but guaranteed to get its money back in a foreclosure.

Title insurance is another area where it’s possible to reduce costs when refinancing. You might, if it’s been less than ten years since your title insurance policy was issued, be able to get the policy reissued, or have a “quick” title search done in preparation for the new policy. A quick search basically looks only for issues that have popped up since you became the home’s owner. Using the same title company as you did when you first bought the house will help with this.

After all these warnings, your ears may perk up when you hear advertisements for “no-cost” mortgages, promising zero closing costs. But these usually charge comparatively high interest or roll your closing costs into the loan amount, so that you pay the same costs eventually. That said, one good time to opt for a no-cost mortgage is if you plan to stay in your house for only a short while, in which case you won’t have time to save much on interest, but will have saved a lot on closing costs.

Your willingness to pay a share of the standard, reasonable costs, and perhaps points, should make you eligible for a competitive interest rate. Just pay close attention and watch out for unexpected or extra-high fees as the process goes along.

Calculating Whether the Savings Will Be Worth the Costs

A common homeowner mistake is to look at what the new monthly payment would be after a refinance and say, “Great, it’s lower than our current monthly payment, let’s do it!”

Even assuming you’re comparing apples to apples (such as a fixed-rate 30-year mortgage to another fixed-rate 30-year mortgage) you’d be leaving out one vital fact: Starting over with a new 30-year mortgage means adding several months or years to your payment schedule. Thought your mortgage would be paid off by the time you retire? You might have just nixed that hope. Also, the more time you take to pay, the more interest you’ll owe in total.

Online calculators can make this easy. To compare fixed-rate mortgages, see Zillow’s Refinance Calculator. Another good resource is HSH's Refinance Calculator, which lets you compare a low-cash-out refinance with a no-closing cost or traditional refinance.

To see whether to switch from an ARM to a fixed-rate mortgage, see the Mortgage Professor’s Refinancing an ARM into a FRM to Lower Risk calculator.

These calculators ask you to input data such as your existing loan balance and terms, how long you have left to pay off your mortgage, any upfront costs and points to refinance, and the new interest rate. You’ll then find out your new monthly payment amount, your total interest savings, and your “breakeven point.”

The breakeven point is especially important. It means the number of months or years it will take you to work off your initial closing costs by saving on interest each month.

If you think you’ll stay in your home for less time than it takes to reach your breakeven point, the refinance definitely isn’t worth it. But if it’s likely you’ll stay long enough to work off these costs, refinancing may be the ticket to reducing your homeownership expenses.

Learn more about finances and taxes for homeowners.

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