When Is the Right Time to Refinance Your Mortgage?

You’ve seen and heard all the ads.

“Mortgage rates are at an all-time low!”
“You’re paying too much for your mortgage!”
“Refinance now and save hundreds of dollars every month!”

And, those enticing statements may even be true. Mortgage rates are low: today’s rates average around 4%, while looking back over the last 20-30 years, interest rates went as high as 12%. Even if you got your 30-year mortgage at the “bargain” rate of 7% back in 2001, that’s still significantly higher than what’s available now—you very well could be paying too much, and refinancing could save you money now and in the long run.

Notice the word could. Although interest rates are lower, the costs associated with refinancing can put you at a disadvantage, and with so many mortgages “underwater” (i.e. owing more to the bank than what the home is currently worth on the market), you might not qualify for a new loan.

So, when is the right time to refinance your mortgage?

When you’ll be staying in the home long enough to recoup your closing costs

Remember when you bought your home, and you found out that there were extra costs that went beyond the purchase price of the house itself? You’ll have to pay for many of those fees a second time in order to refinance: loan origination, appraisal, application, and other closing costs.

Will you be staying in your current home long enough to recover your costs and save money? Do the math. Let’s say you’ll be staying in your house for at least another five years, and your new monthly payment will save you $100 each month. If your refinance will take $3000 out of your wallet, it will take you 2.5 years to recover your costs and might be worth considering.

When you have more than 20% equity in your home

If you have 20% equity or more, you can still avoid private mortgage insurance, or PMI. Otherwise, you’ll likely lose any benefits of refinancing because of the extra monthly charge that is required when a mortgage has less than 20% equity. You should get a rough idea of the current market value of your home before deciding to refinance—sites like Zillow or Redfin can help, but it’s always most accurate to check with a local real estate professional.

When your high-interest debt is paid off

Credit cards can have interest rates that are far higher than what you might be saving by refinancing. Unless you have already paid off your high-interest debt, you should use the money you would have spent on closing costs to pay down your credit cards and other debts first. Mortgage interest is typically tax-deductible, but credit card interest isn’t!

When you have an adjustable-rate mortgage (ARM) with no prepayment penalty

Adjustable-rate mortgages are attractive because of their über-low rates: sometimes as much as a full percentage point lower than their 30-year fixed rate counterparts. They’re also very appropriate for home buyers who know that they’ll only be living in their home for three-to-seven years (e.g. military, frequent job transfers, and so on). Unfortunately, many homeowners get a nasty surprise when they—intentionally or not—reach the date where their rate adjusts…and discover that they’re now paying hundreds of dollars more each and every month.

If you’ve got an ARM that will be adjusting in the next year and there’s no prepayment penalty that would negate your savings, refinancing might be a smart move.

Ultimately, there’s no simple answer to the question, “Should I refinance my mortgage now?” But, with careful consideration of your personal circumstances, your future plans, and your financial goals, you can determine if refinancing would be right for you.