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 common mortgages was between 2.61–3.11%—the lowest they’ve been since Freddie Mac started reporting several decades ago!1,2 And with the Feds saying they won’t raise interest rates until 2023, now even more folks are wondering, Should I refinance my mortgage?3
Lower interest rates are great and all, but how do you know if it’s the right time for you to actually do a mortgage refinance? We’ll show you how to make a smart decision.
Should I Refinance My Mortgage?
Refinancing your mortgage is usually worth it if you’re planning to stay in your home for a long while. That’s when a shorter loan term and lower interest rates really start to pay off!
The savings you could make from refinancing could be used to help you take control of your monthly bills, pay off your mortgage faster, and save for retirement. Just imagine if you owned your home outright!
How to Calculate Your Refinance Savings
Okay, put on your math hat! Let’s say you bought a $300,000 house with a 30-year mortgage at a fixed interest rate of 4% and had a 20% down payment ($60,000).
Pay off your home faster by refinancing with a new low rate!
After around 10 years of paying about $1,150 per month on your mortgage, your loan balance is now at $200,000. You want to save money, so you consider a refinance.
Using our mortgage calculator, you enter your remaining loan balance of $200,000. To test the refi option, you shorten the mortgage term from your remaining 20 years to 15 years and drop your interest rate down a percentage—from 4% to 3%.
You’ll notice that the shorter 15-year term will make your new monthly payment go up from $1,150 to about $1,400 per month—but don’t worry. You’ve probably earned some raises over those 10 years to be able to afford that $250 increase each month. Plus, you’ll pay off your home five years sooner and save $53,000 in interest!
Just make sure your monthly mortgage is never more than 25% of your monthly take-home pay.
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—which includes closing costs that are about 3–6% of the loan amount.4
Continuing with our example, let’s say your refi closing costs are $6,000 ($200,000 x 3%). Great! Now we just need to figure out how long you need to stay in your home for your refi savings to reach that number.
To do this, we need to compare the amortization schedule of your current mortgage to the refinanced option (specifically, how much of your monthly payments go toward interest every year per mortgage).
Will You Stay in Your Home Long Enough to Benefit From a Refi?
Using our example (and the full payment schedule on our mortgage calculator), you’d pay $23,000 in interest over the next three years with your current 30-year loan at a 4% interest rate.
On the flip side, the 15-year refi at 3% interest would only cost you about $17,000 in interest the first three years. That means, after three years, your refi will have made up for its own closing costs ($23,000 - $17,000 = $6,000).
After that, you’ll enjoy thousands of dollars of savings nearly every year until you pay off the mortgage or sell your home! But if you relocate in just 1–2 years after refinancing, you wouldn’t earn back that $6,000 and the refi wouldn’t have been worth it.
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. So ask a home loan specialist you can trust for help—like our friends at Churchill Mortgage.
When Should I Refinance My Mortgage?
The time to refinance is 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 it allows you to:
1. Switch From an Adjustable-Rate Mortgage (ARM) to a Fixed-Rate
With your ARM having adjustable interest rates, you might start off with the first few years at a fixed rate. But after that, the rate can adjust based on a lot of factors, like the mortgage market, and the rate that banks themselves use to lend each other money.
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 compared to ones in the current market, then refinancing could be a smart financial move if it lowers your interest rate or shortens your payment schedule.
If you can find a loan that offers a drop of 1–2% in its interest rate, you should think about it. But remember, refinance only if you’re planning to stay in your home for a long time, because then you can earn back 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—ideally with a new payment that’s no more than 25% of your take-home pay.
But if your interest rate is low enough on a 30-year fixed-rate mortgage to compete with the 15-year rates out there, make sure refinancing just to get the shorter term isn’t going to cost you more. You’re better off making extra payments on your 30-year mortgage every month to shorten your payment schedule.
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 payoff calculator to run your numbers and see what your monthly payment would be on a 15-year loan.
4. Consolidate Your Second Mortgage—Only if It’s More Than Half of Your Income
Some homeowners with second mortgages want to roll it 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 would do better to just pay it off with the rest of your debt through your debt snowball.
But if the balance is higher than half of your annual income, you could 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!
Is It Worth It to Refinance?
If you were already tossing around the idea of refinancing, these low rates couldn’t have come at a more perfect time. Getting a mortgage with a 1–2% drop in interest rate can make a huge difference in your monthly budget and ability to pay off your mortgage faster.
Just remember to do the break-even analysis we mentioned earlier 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.
Refinancing costs usually don’t include property taxes, mortgage insurance and home insurance because they were set up when you first bought your home. Remember, you’re revising the original mortgage, not starting completely from scratch.
Refinance closing costs include:
- Refinance application, new 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 when you close 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.
When Is Refinancing a Bad Idea?
On the other hand, there are definitely times when refinancing your mortgage would not be a good idea. We’ll give you some examples.
It wouldn’t be wise to refinance (and get into more debt) because you want to use the money to:
- Get a new car
- Remodel your kitchen
- Pay off credit card bills
- Roll up other debt (credit cards, student loans, etc.) into a refinanced mortgage
Wiping out your home equity (your home’s current value minus what you owe on it) to buy new stuff you don’t need puts your home at risk—especially if you lose your job or have other money issues.
Also, the reason you don’t want to roll up other debt into one gigantic refinanced mortgage is because you want to pay off your smaller debts first (and get energized from those wins).
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 and finding it hard to pay your mortgage, there’s good news for you. Depending on your specific situation, you may be able to have your mortgage payments lowered or put on hold.5
Doing that can really help to free up the burden you might be feeling right now if you’re worried about when you’ll see your next paycheck.
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 home loan specialists we trust at Churchill Mortgage. They’ll help you get a mortgage you won’t regret!