How Do I Know When It’s Time to Refinance?

Fortunately, the decision to know when it is time to refinance falls outside the realm of life’s philosophical questions as the decision can be reduced to practical, financial terms.

Most homeowners choose to refinance for several specific reasons – which typically have to do with saving money – in one form or another. And while refinancing with an objective to save money is very often possible, the reality is that refinancing should be accomplished at the right time, and only if the decision makes fiscal sense.

The scenarios outlined below help clarify when the time might be ripe for refinancing. Take a moment to review these examples to see if any sound familiar or similar to your situation.

Refinance Scenario #1 – A Better interest Rate is Available

Homeowners should not find it surprising that the interest rate on a mortgage plays a significant role in determining the required monthly payment. And with mortgage rates hovering near, or at, historic lows, many homeowners have begun to seriously consider when and if this is the time to pull the trigger on a mortgage refinance.

So, how does a mortgagor determine when it makes fiscal sense to refinance?

First, it is important to recognize how even a slight interest payment decrease can reduce one’s monthly Principal & Interest mortgage payment and the total cost of the mortgage each year and over the life of the loan.

Note – for the example noted below, the mortgage amount is $250,000, and the mortgage term is 30 years. [Follow this link to a mortgage calculator to help determine your potential savings.]

Interest Rate	Monthly Payment (Rounded)	Payment Difference	Total of All Payments Over 30 Years
4.0%	$1,194.00	—	$429,674.00
4.5%	$1,267.00	$73 per month	$445,017.00
6.0%	$1,499.00	$305 per month	$539,595.00

The difference in the monthly payment for the first two options is $73 per month; however, a homeowner will pay $15,343 less over 30 years for an interest rate that is ½ point lower (4% vs 4.5%) – $445,017 – $429,674 – $15,343.

If a refinance could be accomplished at no cost – with any interest rate deduction, the decision to refinance would be a no-brainer. This is because other than the required paperwork; a homeowner would reap the benefits of a lower payment, which increases the longer the borrower lives in the subject property.

However, as most property owners know, the process to refinance typically includes closing costs, which vary depending on the locale of the property being financed, the loan amount, and several other factors.

So, when do you know if it is time to refinance if there are closing costs involved? The answer lies in the concept of “breaking even” and requires homeowners to ponder the question – How long they intend to live in the property?

In most instances, because of closing costs, homeowners will find that it only makes fiscal sense to refinance if they intend to live in the property for enough time to at least recoup the expenses related to the refinance. Most refinance transactions will require months (if not years) to break even and offer homeowners an opportunity to save money. Here is a quick example to clarify the point –

In the above example, the cost to refinance was $3,840 to move the interest rate down from 4.5% to 4.0%. To determine the break-even point, simply divide the cost to refinance ($3,840) by the proposed monthly savings of $73. [3,840/73 = 52.60], or rounded up – 53 months, which translates to four years and five months.

Therefore, if the homeowner in the above example knows, with relative certainty, that they will be living in the property to be refinanced for at least five years, a refinance would allow them to break-even, and begin saving after month 53.

It is noted that many homeowners find it challenging to quantify their living intentions, and those that do find it challenging should also consider if refinancing has one of the other benefits to offer, as noted below.

Refinance Scenario #2 – Your Credit Has Improved

Another factor that determines the interest rate available for your mortgage loan is the status of your creditworthiness as a borrower – often expressed in terms of a credit score. Credit scores are determined by algorithms and maintained by three primary credit repositories –

• Transunion
• Experian
• Equifax

One’s credit score typically ranges from 300 (at the very lowest) to 850. The better one’s credit score is, the more likely they will be offered the best interest rates available in the marketplace.

If your credit score, when you closed on your current mortgage, was less than stellar, likely, you did not receive the lowest possible rate in the market. But, if you have proactively sought to improve your credit profile (and thus, your credit score), this factor alone may allow you to qualify for a better mortgage interest rate. Again, though, homeowners need to determine if they intend to live in the property long enough to reap the benefits or recoup the funds paid required to refinance.

Refinance Scenario #3 – You Want to Reduce the Term of Your Mortgage

Reducing the term of one’s mortgage loan is a smart way to save money in the long run. There is often a dual benefit in choosing to reduce the term of your mortgage loan. First, most lenders reduce the interest rate for 15-year loans when compared to 30-year loans. Secondly, a shorter term requires fewer payments, which often translates to thousands of dollars saved, over the life of the loan.

Here is an example; the current mortgage is as follows:

• Outstanding Loan Amount – $240,000 (original balance was $250,000).
• Current Monthly P&I Payment – $1,580.00
• Interest Rate – 6.5%
• Year left on Mortgage – 27

If the above homeowner was offered a $250,000 mortgage loan for 20 years at 4%, would it be a prudent decision to refinance? Let’s do the math.

• The Refinance Loan Amount – $250,000.
• Current Monthly P&I Payment – $1,515.00
• Interest Rate – 4.0%
• Year left on Mortgage – 20

The decision to refinance in the above example is an easy decision as the borrower reaps two benefits, as follows:

• The monthly required mortgage payment has been reduced by $65 per month.
• The total payment for the refinanced loan saves $148,320 over the mortgage’s term.

• Total Required to pay off original mortgage – 27 (years) x 12 (months) x $1,580 = $511,920
• Total Required to pay off refinanced mortgage – 20 (years) x 12 (months) x $1,515 = $363,600.

The savings offered by this refinance provide a borrower a savings of nearly 29% over the mortgage term.

It is essential to note that choosing to refinance to a shorter-term mortgage may increase the monthly payment but may provide the opportunity to save tens of thousands of dollars, as follows –

The current mortgage, which differs from the above example, is as follows –

• Outstanding Loan Amount – $240,000 (original balance was $250,000).
• Current Monthly P&I Payment – $1,419.00
• Interest Rate – 5.5%
• Year left on Mortgage – 27

If the above homeowner was offered a $250,000 mortgage loan for 20 years at 4%, would it be a prudent decision to refinance? Let’s do the math.

• The Refinance Loan Amount – $250,000.
• Current Monthly P&I Payment – $1,515.00
• Interest Rate – 4.0%
• Year left on Mortgage – 20

At first glance, the increase in the borrower’s monthly payment of $96 may decide to refinance seem not worthwhile; however, if the borrower chooses to refinance, they will save $148,320 over the loan term because the borrower’s decision to refinance saved seven years of mortgage payments.

• Total Required to pay off original mortgage – 27 (years) x 12 (months) x $1,580 = $511,920
• Total Required to pay off refinanced mortgage – 20 (years) x 12 (months) x $1,515 = $363,600.

Refinance Scenario #4 – Your Adjustable Rate Mortgage (ARM) is About to Adjust

Adjustable-rate mortgages typically offer borrowers an attractive initial rate in which the monthly payment is temporarily lower than one might find with a comparable fixed-rate option. However, when the initial period expires, the adjustable-rate mortgage will adjust to current rates – by using an indexed rate, plus the lender’s margin – which is often determined by one’s credit score.

Even if the potential monthly payment after the ARM rate adjusts appears doable, refinancing with historically low rates now available is a smart way to create a stable monthly payment for your future monthly payments.

Refinance Scenario #5 – You Want to Fund a Large Expense

If you face one of life’s significant expenses and have sufficient equity in your property, a borrower can refinance and pull the funds from the equity using what is known as a cash-out refinance mortgage. The amount of cash a borrower receives will be equal to the new loan amount minus any existing liens on the property and the costs required to close.

Homeowners often choose to refinance to pay for these large expenses, as the interest rates are often the most competitive available on the marketplace –

• Pay off medical debt.
• Fund a child’s college education.
• Consolidate outstanding debt with the benefit of a lower interest rate.
• Fund various home improvement projects, to name a few.

Refinance Scenario #6 – You Want to Reduce Your Monthly Payment

If you suddenly find it challenging to meet your monthly mortgage payment – because of a change in your income or unexpected expenses, choosing to refinance can help reduce your mortgage in two ways:

• By lowering the interest rate.
• By extending the term of the mortgage when refinancing, even without a change in the interest rate.

Here is another example:

• Outstanding Loan Amount – $240,000 (original balance was $250,000).
• Current Monthly P&I Payment – $1,419.00
• Interest Rate – 5.5%
• Year left on Mortgage – 17

The table below reflects how the borrower’s monthly payment for a $250,000 mortgage with a 4% mortgage interest rate, based on a 20, 25, and 30-year mortgage payout.

Interest Rate	Term	Monthly Payment (Rounded)	Savings from Current Payment	Total of All Payments Over 30 Years
4.0%	30 years	$1,194.00	$225 per month	$429,840
4.0%	25 years	$1,320.00	$99 per month	$396,000
4.0%	20 years	$1,515.00	($96 per month)	$363,600

And while the refinance to a 25 or 30-year mortgage will save the borrower money each month, the reality is over the life of the loan, the amount of interest paid will increase simply because you are borrowing the funds for more years.

But, if it is your goal to reduce the monthly mortgage payment, extending the life of the loan is often a prudent way to meet your financial goals.

The Take-Away

Deciding if it is time to refinance is an important financial decision. Homeowners often find it helpful to speak with a mortgage professional who has the skills to refine one’s thinking regarding available mortgage options and the costs to close. Fortunately, it has never been easier to request a rate quote to apply online.

As noted above, even a small change in one’s interest rate, credit standing, or mortgage term can offer borrowers the opportunity to save money, which allows borrowers to divert those savings to funds for other purposes like home improvement, education, or saving for one’s retirement.