How To Know When It’s A Good Time To Refinance
All the headlines lately scream the same thing: INTEREST RATES ARE AT HISTORIC LOWS!!! Amazing, right? Well, it kind of is!! BUT, that doesn’t mean that refinancing is the right option for you. There are a variety of things that you need to consider before making the choice to refinance your home loan.
First, let’s talk about why people refinance in the first place. The most common reason is a better interest rate (and as a result, a lower payment). Then there are some people who choose to take equity out- people do this to invest in other assets, home improvement, debt consolidation, etc. Another reason people refi is to change the duration of a loan term, and finally many people want to drop PMI (private mortgage insurance… which you can learn about from this video)
So now that we’ve covered the four most common reasons that people choose to seek refinancing, lets talk about what you need to consider when making that choice:
Things to consider:
- Current interest rates vs. what you already have,
- The length of time you plan to own the home
- How much the refinance will it cost
So it’s important to pay attention to the relationship between the interest rate you’d have with the refinance, and the one you already have. My personal recommendation is that for it to make sense for you to refinance, you should be saving either a whole percentage point, or at least 200 dollars off your monthly payment.
This obviously depends on what you plan on doing, but if you’re not going to see significant monthly savings from refinancing, it might not make much sense!
When talking with people about refinancing, one of the first questions I ask is “how long do you plan to own this home?”. The reason for this is because if you don’t plan on owning the property for a long period of time, the cost might not be worth it! So often I see people refinance, then decide in 6 months or a year that they want to sell (for whatever reason) and then they never actually recoup the benefit of the refinance.
There are also some people that choose to refinance year after year… they’re constantly rate shopping and end up shaving off 50-100 bucks a month each time they do it. But they’re incurring costs and usually lengthening the term of the loan every time, so they’re not actually saving in the long run!
If you hear nothing else from this, please take away this: If it isn’t a significant savings relative to the length of time you plan on being in the home, DON’T DO IT!!!
When it comes to costs associated with a mortgage or refinance, there are two kinds: Single and recurring. Single costs are the mortgage and title, transfer fees (if there are any), etc. Recurring costs are things like taxes, insurance, and interest.
When we talk about the cost of a refinance, we’re talking about those single costs. The actual money it takes to do the refinance, and not the typical recurring costs that are part of your monthly payment.
So when considering if a refinance is worth the cost, I like to use this simple equation: Divide the monthly savings you will see by the cost of the refinance, which will tell you how long it will take you to break even in terms of cost. My personal advice is that if it will take longer than four years to break even on the cost of the refi, it’s not worth it! This goes back to timing… evaluate how much longer you will be in this home, and make a decision from there.
SIDE TIP!! One thing to note when it comes to mortgages: you’re always one payment in arrears. Remember how when you started paying your mortgage, you skipped that first month? Well, that month wasn’t a freebie, it simply is added on to the very end. So if you find yourself in a position where you’re looking for your pay off balance, keep this in mind!
Now that you have some things to keep in mind when thinking about refinancing, let’s talk about what the market looks like right now, in early 2020. Rates are LOW. Like really really low. We’re currently in the mid 3s, and it looks like we’re headed for the low 3s.
What does this mean for you? Well, if you are someone who has Mortgage Insurance, if you plan on being in the home for a long time, and if you have 20% equity in your home, I think it makes a ton of sense to refinance in the current market. I’m actually personally doing this because I’ve considered the three points listed above, and the rate, timing and cost all make sense for me. That being said, even though I am seeing a significant savings in my monthly payment from this refinance, I’m planning on continuing to make the same payments I’m currently making. The reason I’m doing this is because I want to pay down my mortgage as quickly as possible.
Another thing to consider with rates as low as they are is shortening your term. Depending on where you’re starting from, going from a 30 year to a 15 year mortgage with a much lower rate may end up being a very similar monthly payment. But the shorter loan term will save you money over the life of your loan.
Now let’s talk about debt consolidation. I have mixed feelings on this one. If you’re going to do a cash out refi in order to pay off debt, you need to have strategies in place to prevent you from re-spending that money. So often, people take equity out to pay off debt, but then run debt all over again, and have no equity. I see this happen all the time and DO NOT RECOMMEND IT!
We saw this happen a lot in the early 2000s… people used the equity in their homes as if it was revolving credit. Then when the market crashed, they had no equity in their homes and had nothing to fall back on.
The last thing I want to address as it relates to refinancing is Private Mortgage Insurance. I’ve mentioned this a couple times now, and have linked to a video explaining what PMI is. So the question now is, did you know that if you have a conventional mortgage, have more than 25% equity in your home, and you’ve owned it for more than 2 years, you can request to have it removed? Some people think that it automatically drops off once you reach 25% equity, and this is not the case. PMI does not automatically stop until you reach 78% loan to value. So requesting it when you reach 25% loan to value may be a way to save money on your monthly payment without having to do a refinance. Keep in mind that the mortgage company will have to do their own valuation, but it is absolutely worth looking into if you already have a good interest rate and are looking for ways to save more money.
Refinancing is a super hot topic right now, and it may not be for everyone. BUT, I hope all this information has helped you determine if it’s the right choice for you and for your long term money goals! If you need help getting started, and aren’t sure what your monthly budget should look like, download our free budget guide from the website. It’s my goal to help you make smart money choices, so you can make your financial dreams come true!