When Should You Refinance Your Mortgage?
Record low rate doesn't mean it makes sense right now
Wednesday, October 10, 2012
Maybe you refinanced your mortgage a couple of years ago when rates fell below five percent. After all, you thought, they couldn't go much lower.
But they have. And recent record low mortgage rates have now fallen even more -- to around 3.5 percent. Should you refinance again?
It's a good question and one that doesn't have an obvious answer. It all depends on a number of variables.
Consider the upfront costs
In most cases, it costs money to refinance a loan. There's an appraisal fee and regular closing costs. The mortgage company or broker will also assess a fee. The total of all these costs is something that you'll need to justify.
But first, just how long ago did you last refinance? What were your closing costs? What is your current rate and how much lower is it than the rate that it replaced?
The answers to these questions will tell you whether you have "paid for" your previous refinance. In other words, have you already saved the total you spent on refinancing by having a reduced monthly payment? If not, then the balance should be applied to the cost of a new mortgage.
Typical closing costs
A 2008 survey by Bankrate.com found the typical closing costs on a $200,000 mortgage amounted to $3,100. How quickly can you recoup that cost?
If your current rate is 4.75 percent, the monthly payment on a 30-year fixed rate loan -- not counting taxes and insurance, is $1,355.79. Let's say you can refinance at 3.75 percent for the same term. The monthly payment drops to $1,238.73, a savings of $117.06.
It would take 26 months, or just over two years, to recoup the closing costs. After that time you will begin realizing the savings. Personal finance experts generally advise that a two-year payback cycle is justifiable.
The question to ask yourself is whether you plan to still be living in the house at that time. If you end up selling it before the 26 months is up, then it doesn't really pay to refinance right now.
Payback number could be higher than you think
If it seems like it could go either way, this is where the payback on your previous mortgage comes in. If you still have $700 in unrealized savings on your current mortgage, that $700 should be added to the $3100 costs for the new re-fi. Now it will take 32 months for a lower monthly payment to pay for itself.
There may be other extenuating factors, however, that could justify an early refinance, especially at these low rates. If you have some credit card debt at a very high interest rate that you have been unable to pay, it's possible to roll some or all of it into your new mortgage, assuming you have enough equity in your home.
The savings in interest on the credit card debt -- especially if it is in the range of 20 to 30 percent -- is a strong mitigation in the refinancing equation. Just understand that even though you're paying back that credit card debt at a record low interest rate, you'll be paying on it for as long as you hold the mortgage.