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Three foolproof ways to know when to refinance your mortgage [VIDEO]

Maggie Overholt
The Mortgage Reports editor

Right now you’re asking yourself, “should I refinance?”

With mortgage rates lingering near historic lows, plenty of homeowners are wondering the same.

In fact, a study earlier this year showed that almost 12 million homeowners stood to refinance into a 0.75% lower rate — which could translate into tens of thousands in long-term savings.

Of course, savings will vary greatly from person to person. So, how do you know when it’s the right time to refinance your own mortgage?

There are three sure ways to tell whether you should refinance your home. We’ll explain them in detail below.

Or, if you want the short answer: Check refinance rates and compare them with your current interest rate. If your new rate is significantly lower, odds are a refinance is in your favor.

Verify your refinance eligibility with a personalized rate. Start here (Nov 22nd, 2019)

How to know when to refinance

The general rule of thumb about refinancing is that if it saves you money, you should probably do it.

Even if you just recently bought the home or completed a refinance, it’s probably not too soon to find yourself a better deal.

That said, refinancing isn’t a flip of a switch. It takes some time, and there are closing costs and paperwork to consider. You’ll have to weigh the benefits of a refinance against the pay-in to make your decision.

There are a few ways to tell whether a refinance is worth the effort for you:

  • Break-even: If savings and closing costs will even out and you’ll start seeing returns while you’re in the home
  • Free up some cash: If you can refinance into a lower payment and free up your monthly cash flow
  • Refinance for free: If you can find a refinance program with little or no closing costs

Start by clearly defining your goals. Know what your financial objective is, and how a refinance will help you get there.

Then check refinance rates available to you. If they’re significantly lower than your current rate, a refinance might help you meet your goals sooner.

Verify your refinance rate. Start here (Nov 22nd, 2019)

Refinance strategy 1: The break-even method

Your biggest consideration when refinancing will probably be closing costs. As with the original mortgage, closing costs for a refinance can easily total a few thousand dollars.

With that in mind, the first question to ask yourself is:

Will I stay in the house long enough after refinancing to recoup my closing costs?

You can get a simple answer to this question by dividing your closing costs by your estimated monthly savings. For example:

  • Refinance closing costs and fees: $3,000
  • Monthly savings: $300
  • Time to break even: 10 months

In this scenario, the homeowner won’t start seeing savings until 11 months in. If they’re planning on staying in the house for another few years, a refinance is probably in their best interest.

Calculate your potential savings using a refinance calculator

Here are a couple more tips for calculating your refinance savings:

  • Closing costs to consider include title, escrow, and lender fees. Ignore prepaid items like taxes and insurance, since you’ll have to pay those anyway
  • Look at your interest savings, not your payment savings. The goal is to pay significantly less in interest over the life of the loan, not just to lower your payment

If you’re planning on moving or selling before you’ll break even, take another look at your goals.

There might still be reasons to refinance (like freeing up your cash flow, below), but it’s more likely to be a wash. You might wait till interest rates drop a little lower and you can break even faster.

Refinance strategy 2: The cash-flow method

Saving money over the life of your loan is a great reason to refinance. But it’s not the only one.

Say you’re a few years into your mortgage, and really struggling with monthly payments. (It can happen to anyone.)

Refinancing into a new 30-year term might increase the amount you pay over the life of the loan. But if it lowers your monthly payment and frees up some day-to-day cash? Refinancing might be worth it anyway.

Here’s an example of how this type of refinance might shake out:

  Original mortgage Refinanced mortgage
Loan balance $300,000 $300,000
Remaining term 23 years 30 years
Interest rate 4.75% 4%
Total interest remaining $190,000 $215,000
Monthly payment $1,800 $1,400

This homeowner would save $400 per month by refinancing. That extra cash can make a meaningful dent in monthly bills and living expenses. It could make all the difference in affording their home.

However, refinancing into a new 30-year term also means this person would pay an extra $25,000 in interest over the life of the loan.

Whether or not this type of refinance is worth it depends on your unique situation.

The important thing is that you’re fully aware of both the short- and long-term effects on your bank account before making a decision.

Refinance strategy 3: The no-closing-cost method

There’s one more surefire refinance strategy: The no-closing-cost refinance.

Believe it or not, any lender can offer you a refinance with no closing costs. But it’s not exactly a free lunch.

A no-closing-cost refinance works a lot like discount points, which you may remember from your initial mortgage. It lets you buy down the up-front cost by paying a slightly higher rate over the life of the loan.

That might sound backward, considering that you’re probably refinancing because you want a lower rate.

But if rates are low enough, you can likely see a slight uptick and still save a lot in interest in the long run.

For example, imagine you’re refinancing a 30-year, fixed-rate loan of with a balance of $300,000 and a 4.75% interest rate:

  Refinance with closing costs Refinance with no closing costs
Loan balance $300,000 $300,000
New interest rate 3.75% 4%
Closing costs $3,000 $0
Total interest savings (over 30 years) $93,400 $77,800

Paying $3,000 in closing costs would save this homeowner more over the life of the loan, of course.

But if they can’t (or don’t want to) pay $3,000 out of pocket, they can still save more than $70,000 over 30 years with a no-closing-cost refinance. That’s not a bad deal.

Good reasons to consider a refinance

The three strategies above should help you figure out whether a refinance is “worth it” based on the interest you can save.

But a refinance can help you with other financial goals, too — aside from just reducing your mortgage payments.

Here are just a few good reasons to consider refinancing your mortgage:

  • Cancel mortgage insurance: You can use a refinance to get rid of mortgage insurance (either PMI or MIP) if you’ve built enough equity in the home
  • Reduce your loan term: You can pay off your home sooner by refinancing to a 20, 15-, or 10-year mortgage. Rates are usually lower, but your monthly payment might go up since you’re paying off the loan with fewer payments
  • Get out of an ARM and lock low rates: Adjustable-rate mortgages usually start with low rates, but they can spike later. Refinancing into a fixed-rate loan can help you lock in a low rate for the rest of your term
  • Get cash out: As you pay down your mortgage, your home equity grows. A cash-out refinance lets you access some of that equity money to pay for renovations, kids’ college tuition, or other big-ticket items
  • Consolidate debt: You can also use a cash-out refinance to pay off high-interest debt, like from credit cards or personal loans, at a lower interest rate. Use extreme care with this method, as it’s easy to run debts back up and end in a worse place than where you started
  • Pay off liens, second mortgages, or judgments: If you’ve taken out a second mortgage (“piggyback” loan), home equity line of credit, or other judgment on the property, you can use a cash-out refi to pay these things off

You can learn more about these refinance strategies in our complete guide to refinancing a home.

Your next steps

First, sit down and outline your financial goals. Decide if, and how, a refinance will help you meet those goals.

Next, check personalized interest rates. Your new rate is key to determining how much you could actually save and whether a refinance is worth it.

If a refinance seems like the right move, compare a few different lenders. Find the best refinance deal for you, and work with that lender to get the ball rolling.

Start your refinance here with a personalized rate quote (Nov 22nd, 2019)