How do I know if I should refinance?

The question we’ve been asked the most since we started writing mortgages has been: How do I know when it’s time to refinance? The old conventional wisdom said to do it when rates drop 2% below your current mortgage, but this rule of thumb is too simplistic. The higher your loan balance, the smaller the percentage difference in rate needed to make your closing costs worthwhile. Due to inflation, the average home value and therefore the average mortgage balance today is much higher than it was in the past. If you live in a high-cost area, your mortgage may have a higher balance. Also, closing costs can vary widely from state to state; New York, for example, is considered a high closing cost state by the Federal Housing Authority (FHA).

There are several things to consider when deciding whether to refinance:

  1. Monthly savings that will come from the decrease in the rate. It is very important to do the calculations for your specific situation. The taxes and insurance stay the same because they don’t depend on whether your loan changes, but they still look at your full monthly payment in case it goes up.
  2. Whether there are any prepayment penalties or early closing fees applicable to your current mortgage(s), including any second mortgage or home equity loan/line of credit. You should pull out your closing documents and read the details. Don’t trust your memory of the last transaction, read your documents again. We’ve found that people’s memory of old transactions is often not as good as they think, and if we don’t help you with the last transaction, we won’t know without seeing your documents. We’re always happy to go over them with you if you’d like. Just because some early closing fees apply doesn’t necessarily mean a refinance won’t be worth it. A good mortgage broker can help you decide when a refinance is recommended based on the specifics of your situation.
  3. Your closing costs which may vary depending on: whether a “streamlined” refinance is possible and worthwhile, whether your property is a co-op, whether it’s an investment property, whether a no-closing-cost loan is available to you. (link to page that explains the difference between prepaid and closing costs)
  4. How long it will take to pay your closing costs.
  5. When is the property likely to sell? If you don’t know, try to estimate the earliest time you think you’ll sell and the longest time you expect to own. If you’re going to sell before you recover your closing costs, it’s not worth it.
  6. How long it will take you to own the property free and clear.
  7. Factors other than rate – These usually need to occur along with a rate decrease to get the most benefit for you, but they can make a refinance more worthwhile – cheaper cash for improvements or shorter term to pay off your loan sooner of time. A word about debt consolidation: This may be worth it, but keep in mind that if you re-accumulate credit card debt, you’ll have a larger mortgage Y credit card debt.

Reasons not to refinance:

  1. Only for the tax deduction without any other benefit. Why pay $100 in interest just to pay $30 less in taxes? You are still $70 poorer.
  2. For the rate, but without taking into account the “big picture” savings in dollar terms. This is generally true if your balance is extremely small and you don’t need cash.
  3. If you probably won’t own the property long enough to recoup your closing costs, see the discussion above (or link to the same page)

Also, if you’re considering getting an adjustable rate mortgage (or ARM) (whether you currently have one or not), visit this site for my article titled How would an adjustable rate mortgage affect you?

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