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Even when mortgage rates drop, the decision to refinance a home loan can be an uncertain one. It may make sense to refinance if:
- You can refinance your fixed-rate mortgage into a lower fixed-rate mortgage rate as a no-closing-cost loan
- A change in market conditions (such as lower mortgage rates or higher home values) makes a refi financially beneficial
- You can use a cash-out refinance to consolidate debt, make home improvements, or fulfill a legal obligation
Does it make sense to refinance?
Unsure about whether you should refinance? Yeah, you and everybody else. Even when mortgage rates drop, the decision to refinance a home loan can be an uncertain one.
The problem is that the shortcuts we’re taught — the “rules of thumb” of when to refinance and when to pass — don’t actually work.
As a result, homeowners often refinance when they shouldn’t; and, don’t refinance when they should. Consumers spend billions of dollars extra in mortgage interest each year simply because they opted not to refinance.
Today, there are millions of U.S. homeowners potentially eligible to refinance. Maybe you’re one of them. What’s keeping you from moving ahead?
What is a refinance?
To refinance a mortgage means to replace an existing mortgage loan with a new one. With a refinance, the principal balance of the existing loan is paid-in-full using the balance of the new loan.
When the refinance is complete, your old loan is retired — replaced with a new mortgage loan with new mortgage terms.
There are lots of reasons why a homeowner would want to refinance.
Sometimes, a homeowner refinances to exploit a change in market conditions, such as a change in today’s mortgage rates or a rise in local home values. A new mortgage can give lower mortgage rates or payments to the homeowner, and can remove private mortgage insurance (PMI) payments.
Other times, a homeowner refinances to take “cash out” for a home improvement project, or to fulfill legal obligations, such as the removal of an ex-spouse from a mortgage loan.
There are dozens of reasons why a homeowner would want to refinance. However, the two most common reasons are to lower the loan’s mortgage rate; and, to lower the loan’s monthly payments.
When you’re considering a refinance, then, define your goal first — what is it you’re trying to accomplish? Then, consider all of your available mortgage refinance options.
If your current loan is an FHA loan, for example, you could potentially refinance via the FHA Streamline Refinance program, which does not require the verification of income, assets, or credit; nor an appraisal of the home.
Or, you could look at refinancing into a conventional mortgage which might allow you to .
In many cases, canceling your FHA MIP is the better option. However, you wouldn’t know that unless you looked at all of your available options.
The same is true when considered a cash-out refinance as compared to opening a second mortgage home equity line of credit (HELOC). At first glance, the HELOC may look like your best option. Over a 10-year period, however, it may not be.
The “break even” method is flawed
When you’re deciding whether to refinance, financial pundits will often recommend to you the break-even method.
In a refinance, the “break-even” method is finding the number of months it would take to recoup the costs of your refinance, and deciding whether you’ll have your mortgage for more or less than that number of months.
So, if your current mortgage payment is $1,500 and your mortgage payment after the refinance drops to $1,400, and your closing costs are $1,000, you can solve for your break-even like this:
- Refinance costs = $1,000
- Monthly savings = $100
- Break-even = 10 months
If the loan’s break-even point is 10 months, and you plan to keep your mortgage for at least 1 year, refinancing probably makes sense.
However, if you’ve had your current mortgage for a long time, the break-even calculation begins to show a flaw. The flaw is linked to your new starting balance, which is lower than what the starting balance of your existing loan was some number of years ago.
Because your new starting balance is lower than the old one, and because mortgage payments are constant from month-to-month, you get a payment reduction from your loan’s “restart.”
To help this concept hit home, pull up a mortgage calculator and follow these steps.
Input a home value of $250,000, with an interest rate of 5.0 percent, a loan term of 30 years, and a $50,000 down payment.
Click “View Full Report.” You’ll immediately see a principal + interest payment of $1,074 per month.
Now, scroll down to Year 5 of the report. You’ll see a remaining mortgage balance of $183,658. If you decided to refinance after five years, this value would be your new starting loan amount.
Go back to the calculator and input the same loan — except, this time, use $183,658 as your mortgage balance.
All you’ve done is restart your loan to a new 30-year schedule, which will cost you more in long run.
Now, look at the payment. You’ll see it’s dropped to $986 per month. However, there is no real savings happening here. All you’ve done is restart your loan to a new 30-year schedule, which will cost you more in long run.
The longer you wait to refinance, the less effective the break-even method becomes. Thankfully, there’s a better way.
The zero-closing cost, “no brainer” refinance
We can’t rely on the break-even method to tell us whether it’s a good idea to refinance, so what do we do? We look for other good reasons to refinance.
For example, if you can refinance your fixed-rate mortgage into lower your fixed-rate mortgage rate, and do it as a zero-closing cost refinance, it makes sense to refinance.
A zero-closing cost mortgage is one for which the lender pays all of the borrower’s closing costs, usually in exchange for a small increase to the mortgage rate.
You won’t get the absolute lowest mortgage rate possible with a zero-closing cost refinance, but that’s okay. The goal isn’t to get the lowest mortgage rate possible — it’s to save money while spending nothing to do it.
Then, if the idea of extending your mortgage by another few years makes you uncomfortable, remember that you reserve the right to pay as much to your mortgage each month as you wish.
If you refinance with a zero-closing cost mortgage, but keep sending your “old” mortgage payment to your lender each month, your new loan will get paid-off faster than if you had not refinanced at all.
You’ll pay less interest, you’ll own your own home sooner — and you will have paid nothing to do it.
Zero-closing cost refinance loans can be a no-brainer. Ask your lender for zero-cost rate quotes.
What are today’s mortgage rates?
Deciding whether to refinance is a personal decision, and sometimes a tricky one. However, there are ways to determine whether a refinance is right for you.
Follow the below link to get help with the decision or to simply start your application immediately.