Q: How do I know when it's time to refinance?
A: When mortgage rates are falling, many homeowners question whether or not they should be applying for a new home loan. Traditionally, financial experts used to tell homeowners to refinance when mortgage rates dropped two percentage points below their current rate.
Today, those old rules no longer apply. Some homeowners have opted to refinance their home loans when mortgage rates declined by as little as one-half percent from their current rate. However, the decision to refinance should be based on a variety of factors in addition to mortgage rates.
First, you should decide how long you intend to stay in your home. Refinancing costs money, so you need to make sure you will recoup your closing costs and truly save.
The simplest calculation is to figure out your monthly savings (e.g., $200) and your closing costs (e.g., $2,000), and divide your savings into your costs to find your break-even point, in this case, 10 months. But getting your money back is only one consideration; you need to be aware of the long-terms costs, too. Use HSH.com's Tri-Refi refinance calculator to see comparisons of costs and savings over time.
Remember, when you refinance into a new loan, you not only have closing costs, which some borrowers choose to wrap into their loan balance, but you may also be extending your loan repayment period. If you have already paid off seven years of a 30-year mortgage and refinance into a new 30-year mortgage, you will be paying for your home for 37 years, which means seven extra years of principal and interest payments. -- Visit HSH.com's Mortgage calculator to your monthly mortgage payments.
While this would lower your monthly payment and improve your cash flow situation nicely, it will make it very hard to actually save any money over the long haul, and you'll also go back to building equity at a snail's pace.
If your goal is to save money, you might consider taking a new loan with a term shorter (or at least not much longer) than your existing loan, or refinancing and prepaying your mortgage. You can actually make your mortgage be whatever term you like through prepaying -- check out HSH.com's It's My Term prepayment calculator to see how short of a term you can afford.
Financial planning and refinancing
Before deciding to refinance, you should think about your overall financial goals. Are you interested in reducing your monthly payments or paying off your mortgage sooner or perhaps taking cash from your home equity for tuition payments, home improvements or to pay off more expensive debt?
Your mortgage payments may be higher if you choose a shorter loan term or take out cash, but the benefits could be worth it.
Another consideration should be your savings for college tuition and retirement. Depending on mortgage rates, you may be able to reduce your mortgage payment and contribute more money each month to savings.
Consult with a mortgage lender to review interest rates and closing costs to decide how a new home loan fits into your financial plan. Also, be sure to check out HSH.com's tools, calculators and articles to learn how to reach your refinancing goals.
Michele Lerner contributed to this answer.
More help from HSH.com
When refinancing at a higher rate makes senseTrade your old mortgage for a new, higher-rate version? There are times when it actually makes sense.
Should I pay off a mortgage early?By making extra principal payments or refinancing your mortgage, you could pay a lot less interest and free yourself from your mortgage ahead of schedule. Here are the pros and cons of retiring your mortgage early.
Are ten-year fixed-rate mortgages (FRM) available anywhere?Sure! Virtually all lenders who sell product to Fannie Mae or Freddie Mac will be able to offer you mortgage with a 10-year term. However, interest rates are usually the same as the lender's 15-year offerings.