Should you refinance your mortgage?

When current mortgage rates drop below the rate you’re paying on your home loan, you might wonder whether you should refinance.

A good rule of thumb is to consider it if your new interest rate would be at least 1% lower than your current interest rate. This drop will cut your monthly payment by $65 for every $100,000 borrowed.

It’s OK to refinance your mortgage more than once, even if you’ve refinanced in the last couple of years. You just need to make sure you’ll still come out ahead after paying closing costs.

Suppose you want to refinance a $200,000 mortgage for a new loan that charges 1 percentage point less. Closing costs will be $4,000. The new loan will cut your monthly payments by $130 for an annual savings of $1,560.

Divide the total closing costs by your annual savings to see how many years it will take you to break even. In this case, it’s a little more than 2 ½ years.

Ideally, you’d like to break even in 1 to 2 years. A longer break-even period means the closing costs are too high for the interest rate the lender is offering you.

You won’t start coming out ahead from the refinance until after the break-even period. In this example, if you had to move in a year and a half, you’d lose money from refinancing.

Lowering your monthly mortgage payment could help you pay off your home more quickly by freeing up more cash to put toward prepaying your mortgage principal. It could also help you pay down higher-interest debt, like a credit card balance, or make it possible to pay cash for major expenses that you’d otherwise have to finance, like your child’s tuition.

Most people have 30-year, fixed-rate mortgages, and when they refinance, they assume they should get into another 30-year, fixed-rate loan so their monthly payment will be lower.

Any time you refinance, however, you should consider whether you can afford to finance into a shorter term.
There’s a good chance you can afford it if:

  • you’ve paid down your mortgage principal significantly.
  • your new interest rate will be considerably lower than your existing interest rate.
  • your income has increased since you took out your mortgage.
  • you have less debt since you took out your mortgage.

The monthly payments may be higher with a shorter loan term, but you’ll pay less interest overall. In the long run, that decision could give you a lot more money for retirement and other goals.

Use our simple amortization calculator to see how much you could save.

Here’s an example: If you financed $100,000 for 30 years at 4.5%, your interest payments would total $82,407. If you financed $100,000 for 15 years at 3.5%, your interest payments would total $28,679.

What could you do with an extra $53,728?

Use our mortgage refinancing calculator to see what your new monthly payment would be, calculate your interest savings, and see how many months it will take you to break even after closing costs.

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