Ever since the Federal Reserve dropped interest rates in 2020, there’s been a new wave of hype around getting your mortgage refinanced. And for good reason too.
Last year, the annual average interest rates for 15-year mortgages ranged from 2.15–2.39%—the lowest they’ve been since Freddie Mac started reporting three decades ago!1 Rates were higher for 30-year mortgages, but not by much—they sat anywhere from 2.74–3.10%.2
But with the Feds prepping for up to four—yes, four!—rate hikes in 2022, those low rates are going to start climbing fast.3 And that leaves a lot of folks wondering, Should I refinance my mortgage before the rates go up?
It’s a good question! The answer is, it depends. Low interest rates are great and all, but the truth about refinancing your mortgage is that there are right—and wrong—times to do it. And those times aren’t always based on interest rates.
We’ll walk you through the basics of when you should refinance your mortgage and how to know if your refinance is worth it so you can make a smart decision for yourself.
Should I Refinance My Mortgage?
Refinancing your mortgage is usually worth it if you’re planning to stay in your home for a long time. That’s when a shorter loan term and lower interest rates really start to pay off!
Pay off your home faster by refinancing with a new low rate!
You could use the money you save from refinancing to help you take control of your monthly bills, save for retirement, and pay off your mortgage faster. Just imagine if you owned your home outright!
When Should I Refinance My Mortgage?
You should refinance when you want to make a less-than-desirable mortgage better. Most of the time, it’s a good idea to refinance your mortgage if you can do any of these things:
1. Switch From an Adjustable-Rate Mortgage (ARM) to a Fixed-Rate
With an ARM, you might start off the first few years at a fixed interest rate. But after that, your rate can change based on a lot of factors, like the mortgage market and the rate that banks themselves use to lend each other money.
That way, the mortgage lender doesn’t feel the effects of those changing interest rates—you do. Oh and when we say changing, most of the time that means increasing. So if the interest rate goes up, your monthly mortgage payments go up too.
The bottom line is, ARMs transfer the risk of rising interest rates to you—the homeowner.
So, in the long run, an ARM can cost you an arm and a leg! That’s when refinancing into a fixed-rate mortgage could be a good financial move. It’s worth it to avoid the risk of your payments going up when the rate adjusts.
2. Reduce Your High Interest Rate to a Lower Rate
If your mortgage has a higher interest rate than others in the current market, then refinancing to lower your interest rate could be a smart choice—especially if it shortens your payment schedule.
How much lower does the interest rate need to be for a refinance to be worthwhile? That depends somewhat on the market and somewhat on your current situation. In general, if you can find a loan that drops 1–2% off your interest rate, you should think about refinancing.
But remember, a refinance comes with closing costs. So you should only refinance if you’re planning to stay in your home for a long time so you have time for your interest savings to make up for what you paid in closing costs.
3. Shorten the Length of Your Mortgage Term (Shoot for 15 Years or Less)
If your original mortgage is a 30-year term (or more), then refinancing is a good way to get to the ultimate goal of locking in a 15-year fixed-rate mortgage.
We say 15-year fixed-rate mortgages are the goal because they’re better for you than 30-year mortgages. You’ll pay off your house quicker and save a ton of money since you’re skipping 15 years’ worth of interest payments. (Score!)
Now, a 15-year fixed-rate mortgage will likely increase your monthly payment a bit. Just remember to keep your new payment to no more than 25% of your take-home pay.
It all boils down to this: You want to own your home as soon as possible instead of your home owning you! Use our mortgage calculator to run your numbers and see what your monthly payment would be on a 15-year loan.
4. Consolidate Your Second Mortgage—if It’s More Than Half Your Yearly Income
Some homeowners want to roll their second mortgages into a refinance of their first mortgage. But not so fast! If the balance on your second mortgage is less than half of your annual income, you’d do better to just pay it off with the rest of your debt through your debt snowball.
If the balance is higher than half of your annual income, you should refinance your second mortgage along with your first one. This will put you in a stronger position to tackle the other debts you might have before you pull your resources together to pay off your mortgages once and for all!
When Is Refinancing a Bad Idea?
Okay, so we’ve covered four times you probably should refinance. But the truth about refinancing your mortgage is that there are definitely times when you shouldn’t do it. We’ll give you some examples.
It would be a bad idea to refinance (and get into more debt) because you want to:
- Get a new car
- Pay off credit card bills
- Remodel your kitchen (or any other part of your property)
- Roll up other debt (credit cards, student loans, medical bills, etc.) into a refinanced mortgage
Wiping out your home equity (aka the part of your home you’ve already paid for) to buy new stuff you don’t need puts your home at risk—especially if you lose your job or have other money issues. And as much as you may not like your cramped kitchen or your old, out-of-style car, you don’t need a new one!
You shouldn’t consolidate or roll up other debt into one gigantic refinanced mortgage because it’s best to pay off your smaller debts first. Winning with money is 80% behavior and 20% head knowledge. So you get in the habit of paying off those small debts, get energized from those wins, and then you’re ready to tackle the mortgage!
Oh, and a word to all you student loan holders out there: Lumping your student loan debt into your mortgage means it’s going to take a lot more time to pay off those loans and your mortgage too. It puts you even further away from completing either of those goals. No thanks!
What if I Can’t Pay My Current Mortgage?
If you’re out of work right now or you’re finding it hard to pay your mortgage due to events you couldn’t control, don’t lose hope! Depending on your situation, you may be able to get financial assistance through a federal or state program, have your mortgage payments lowered, or even put your payments on hold for a little while.
Doing that can help lift the burden you might be feeling right now if you’re worried about when you’ll see your next paycheck. But it’s not a perfect solution. The best thing you can do right now is get back into the workforce—even if that means taking a job that’s outside your field—so you can start making ends meet.
Now if you can’t pay your mortgage for some other reason (like you bought too much house or you’re overspending on lifestyle things), you’re probably not going to get much help from your lender. It’s up to you to solve the problem.
You’ve got to take control of the things you can control—starting with your money! With a Ramsey+ membership, you can get all the tools and content you need to take control of your money so you can save, build wealth, and get out of debt. And that includes your mortgage!
How to Decide if Your Refinance Will Be Worth It
Okay, so you looked at all your options, and you’re pretty sure you should refinance your mortgage. Now it’s time to put on your math hat and make sure that refi will be worth the effort!
Calculate Your Refinance Savings
Now, this section is going to get a little long and a lot nerdy, but it’s super important. So hang in there with us!
Let’s say Tom and Patty bought a $300,000 house. They paid a 20% down payment ($60,000). And they have a 30-year mortgage at a fixed interest rate of 4%.
After around 10 years of paying about $1,150 per month on their mortgage, Tom and Patty’s loan balance is now at $190,000. They want to save money on interest, so they consider a refinance.
To see if the refi is a good idea, they use our mortgage calculator. Here’s how they get started:
- Enter the home value as $190,000 (the amount they still owe on the old mortgage).
- Put 0% as the down payment.
- Shorten the mortgage term to 15 years.
- Drop their interest rate down to 3%.
(For the sake of this example, we’re not including private mortgage insurance, property tax, home insurance or HOA dues. So when you’re ready to test your own refi, make sure you plug in all those costs so you get the right result.)
The mortgage calculator result helps Tom and Patty do two things.
First, they can see how much their new mortgage payment is. Now, the shorter 15-year term will make Tom and Patty’s monthly payment go up from $1,150 to about $1,300 per month, and it’ll make yours go up a little too.
But don’t worry. Like them, you’ve probably earned some raises over those 10 years that’ll help you afford a higher monthly payment. Just make sure your mortgage payment is never more than 25% of your monthly take-home pay.
Second, now Tom and Patty can compare how much they’ll pay in interest with the new loan versus the old loan. Here’s how they (and you) will do that:
- Look at the amortization schedule (aka the calendar of how much interest the homeowner pays each year).
- Add up all the interest for the 15-year loan, plus any interest already paid on the old loan.
- Subtract that amount from the total of all the interest to be paid on the original 30-year loan to see how much you’ll save.
For Tom and Patty, that looks like this:
$172,500 - $132,800 = $39,700
That’s a big savings, and they’ll pay off their home five years sooner—so that refi is looking pretty good! We still have to check a couple more things, though, so keep reading.
Do a Break-Even Analysis
Here comes the tricky part: the break-even analysis. This is when you compare your refinance savings to how much it costs to do the refi. The results will show you how long you need to stay in your home to make the refi worth it.
Refinancing includes closing costs that are about 3–6% of the loan amount.4 Those costs cover:
- Refinance application, home appraisal and title search
- Home inspection fee
- Lender’s attorney review fee
- Origination fee
- Points fees
While you may not be able to avoid all of these closing costs, you can avoid paying for mortgage points—fees you pay to the lender in exchange for a lower interest rate. Just ask for a par quote or zero quote. That means the closing cost estimates will not include points. (And don’t worry, you can still lower your interest rate from the original loan.)
Refinancing costs usually don’t include property taxes, mortgage insurance and home insurance because those things were set up when you first bought your home. Remember, you’re revising the original mortgage, not starting completely from scratch.
Now that you know what’s included in closing costs (and what isn’t), let’s go back to our example. Imagine Tom and Patty’s refi closing costs are 3%.
$190,000 x 3% = $5,700
So now we can factor in how long they need to live in their home for their refi savings to recoup their closing costs. To do this, we need to compare the amortization schedule of the current mortgage to the refinanced option.
Using our example (and the amortization schedule on our mortgage calculator), you can see that Tom and Patty would pay around $21,600 in interest over the next three years with their current 30-year loan at a 4% interest rate.
On the flip side, the 15-year refi at 3% interest would only cost them about $15,700 in interest the first three years. Then they subtract the refi interest from the original loan interest during that timeframe, like this:
$21,600 - $15,700 = $5,900
That $5,900 is more than the $5,700 closing costs Tom and Patty will pay when they refinance. Once they save enough in interest to cover the closing costs, they’ll hit their break-even point! So in this case, the break-even point is just three years. After that, the savings start to stack up!
But if Tom and Patty relocate in the next 1–2 years, the amount they’ll save won’t even be enough to cover their closing costs, and the refi won’t have been worth it.
After you hit your own break-even point, you’ll enjoy thousands of dollars of savings nearly every year until you pay off the mortgage or sell your home! The longer you stay in the home, the more the savings rack up.
Whew—that’s a lot to throw at you! And we know that even when using a mortgage calculator, the math can be pretty complicated. If you’re ready to try it for yourself, just plug in your info and nerd out!
Want a helping hand? We don’t blame you! Ask a home loan specialist you can trust for help—like our friends at Churchill Mortgage.
Is It Worth It to Refinance?
By now you probably know what we’re going to say, but we’ll say it anyway: Only you can know if it’s worth it to refinance your mortgage, because it depends on your situation. But we can give you some general guidelines to sum it up.
If you’re planning to move soon, want to roll other types of debt into your refi, or are trying to avoid putting in the work to save up for things you want, then the answer to the question “should I refinance my mortgage?” is a big hairy no!
But if you want to get a shorter loan term, drop down to a lower or fixed interest rate, or consolidate a hefty second mortgage, then there’s a good chance that refinancing will be worth it.
Just remember to do the break-even analysis to make sure you’ll stay in your home long enough for your refinancing savings to cover the cost it takes to do the refi.
Get Help With Your Mortgage Refinance
If you want to learn more about mortgage refinancing and how to do it, or if you’re ready to refinance now, connect with the RamseyTrusted home loan specialists at Churchill Mortgage. They’ll help you get a mortgage you won’t regret!