One of the questions homeowners ask me most often is:
“How much do rates have to drop before it makes sense to refinance?”
My answer is:
There isn't one percentage that works for everyone.
I've been helping homeowners with mortgage financing since 1999, and I don't believe in the old rule that says interest rates have to fall 1% or 2% before you should consider refinancing.
A refinance can make sense with a smaller rate reduction if the costs are low enough.
And a large rate reduction doesn't necessarily make a refinance worthwhile if the costs are excessive or the new loan is structured poorly.
When I evaluate a refinance, I want to look at the entire transaction:
Interest Rate + Closing Costs + Monthly Savings + Remaining Loan Term + Principal Reduction + Break-Even Period
The objective isn't simply to get you a new mortgage.
It's to determine whether the new mortgage actually puts you in a better financial position.
— John Madden
Owner, Capital Funding Mortgage Associates
Mortgage Professional Since 1999 | NMLS #960139
Before looking at a new mortgage, I want to understand your existing one.
Important information includes:
This matters because we're not comparing a new mortgage with nothing.
We're comparing it with a mortgage you already have.
And sometimes the mortgage you already have is the better deal.
You may have heard:
“Don't refinance unless the rate drops at least 1%.”
Or:
“Rates need to fall 2% before refinancing makes sense.”
I don't use either rule.
Consider two homeowners.
One can lower the rate by only 0.50%, but the lender provides enough credit to cover most or all eligible closing costs.
Another can lower the rate by 1.50% but has to spend $8,000 to obtain the new mortgage.
Which refinance is better?
You can't answer that from the rate reduction alone.
You have to see the numbers.
One of the first calculations I use is the break-even period.
Suppose refinancing costs $4,000 and reduces your monthly payment by $200.
The simple calculation is:
$4,000 ÷ $200 = 20 months
It takes approximately 20 months for the monthly savings to recover the $4,000 cost.
If you expect to keep the mortgage considerably longer than 20 months, the refinance deserves further consideration.
If you're likely to sell the home in a year, spending $4,000 to save $200 per month probably doesn't make sense.
This isn't the only calculation that matters, but it's a very useful starting point.
A zero-closing-cost refinance can sometimes be a very attractive option.
But it's important to understand what the term means.
The closing costs don't simply disappear.
Generally, the lender provides a credit that offsets eligible closing costs in exchange for the borrower accepting a higher interest rate than might otherwise be available.
For example, you might have a choice between:
Lower interest rate
$5,000 in closing costs
Slightly higher interest rate
Lender credit covering the eligible closing costs
Which is better?
That depends upon the monthly payment difference and how long you expect to keep the mortgage.
I particularly like evaluating zero-cost structures when there's a reasonable possibility that the homeowner may refinance again if rates improve further.
Why spend thousands of dollars obtaining today's rate if you might replace the mortgage again before recovering that money?
LEARN ABOUT RATES, POINTS & CLOSING COSTS →
This is especially important when reviewing a refinance Closing Disclosure or Loan Estimate.
Your transaction may require money for:
Those aren't necessarily the same thing as the actual cost of obtaining the new mortgage.
If your existing escrow account has a balance, that account is generally handled separately from the establishment of the new escrow account.
When I evaluate whether a refinance makes financial sense, I focus heavily on the actual transaction costs, not simply the total number shown as cash required at closing.
This is one of the most overlooked issues in refinancing.
Suppose you originally took a 30-year mortgage and have already been paying it for eight years.
You now have approximately 22 years remaining.
If you refinance the balance into a new 30-year mortgage, your monthly payment may drop substantially.
That sounds great.
But you've also extended the scheduled repayment period from approximately 22 years back to 30.
A lower payment doesn't automatically mean a better financial result.
When I analyze the refinance, I want to compare:
Existing remaining term
New loan term
Monthly payment
Interest expense
Principal reduction
Closing costs
Expected time in the mortgage
Sometimes restarting a 30-year mortgage makes sense.
But you should understand what you're doing before making that decision.
A refinance can also be an opportunity to accelerate repayment.
For some homeowners, moving from a 30-year mortgage into a 15-year mortgage can provide:
The payment will generally be higher than a comparable 30-year mortgage.
But if the payment comfortably fits your budget, the amortization can be very attractive.
I like to show clients the actual balance difference after five and ten years rather than simply showing the monthly payment.
SEE 15-YEAR VS. 30-YEAR MORTGAGE →
Some homeowners consider refinancing because they want to eliminate private mortgage insurance.
That can make sense.
But before refinancing solely to eliminate PMI, I recommend determining whether your existing PMI can be removed without refinancing.
Depending upon the mortgage, current balance, original value, current value and applicable requirements, you may have cancellation options.
If you can remove PMI from an attractive existing mortgage without replacing the loan, that may be preferable to refinancing.
LEARN ABOUT PMI AND PMI REMOVAL →
Homeowners with FHA financing sometimes consider refinancing because of mortgage insurance.
Depending upon the circumstances, refinancing from FHA into conventional financing may reduce or eliminate mortgage-insurance expense.
But again, don't look only at the mortgage insurance.
We need to compare:
Current FHA rate
Current mortgage-insurance expense
New conventional rate
New payment
Closing costs
New loan term
Available equity
A refinance should improve the overall financing—not merely eliminate one line item from the monthly payment.
A cash-out refinance allows an eligible homeowner to replace the existing mortgage with a larger mortgage and receive part of the equity in cash, subject to applicable program requirements.
Homeowners may consider cash-out refinancing for:
The important thing to remember is:
You're converting home equity into mortgage debt.
That doesn't make cash-out refinancing inherently good or bad.
It means the reason for borrowing the money matters.
This can look extremely attractive.
Suppose you have credit-card balances carrying very high interest rates and you can replace them with mortgage debt at a much lower rate.
The monthly savings could be substantial.
But there are two issues I always want borrowers to understand.
Credit-card debt and mortgage debt are not the same.
A mortgage is secured by your property.
If a homeowner uses home equity to eliminate $40,000 of credit-card debt and then accumulates another $40,000 on the cards, the refinance hasn't solved the underlying problem.
You now have more mortgage debt plus new credit-card debt.
Debt consolidation can be useful, but only when it's part of a sensible financial plan.
If you have an adjustable-rate mortgage, refinancing into a fixed-rate mortgage may provide payment stability.
The decision depends upon:
An ARM isn't automatically a bad mortgage.
But if you're approaching an adjustment and want long-term payment certainty, it's worth evaluating your options.
Maybe.
But don't assume the lowest available rate is automatically the best option.
Suppose paying $4,500 in discount points lowers your payment by $90 per month.
The simple break-even period is:
$4,500 ÷ $90 = 50 months
That's more than four years.
If you sell or refinance again before then, you may never recover the additional upfront cost.
On the other hand, if you expect to keep the mortgage for many years, paying points could potentially make sense.
The question isn't simply “What's the lowest rate?”
It's:
“What does that rate cost me, and how long will it take to recover that cost?”
Sometimes borrowers prefer to finance closing costs rather than pay them out of pocket.
That may be possible depending upon the transaction and available equity.
But remember:
Financing the costs doesn't make them free.
It increases the mortgage balance.
When comparing options, I'll show you the effect on both:
Cash required at closing
and
New mortgage balance.
This can make sense in some situations.
If you're planning a substantial kitchen renovation, addition or other improvement, home equity may provide access to funds at a rate below many unsecured borrowing options.
But a cash-out refinance isn't the only possibility.
Depending upon your existing mortgage rate and circumstances, you may also want to compare alternatives such as a home-equity loan or home-equity line of credit.
For example, if you already have an exceptionally low first-mortgage rate, replacing the entire mortgage just to obtain a relatively small amount of cash may not be attractive.
I prefer to look at the whole financing structure.
Suppose you have a 3% fixed mortgage.
Today's mortgage rates are substantially higher.
You need $75,000 for a home improvement.
Refinancing a large existing balance from 3% to a significantly higher rate just to access $75,000 may be expensive.
That doesn't automatically mean you shouldn't do it.
But it does mean we should compare other borrowing alternatives before replacing an unusually favorable first mortgage.
Sometimes the best mortgage advice I can give a homeowner is:
Keep the first mortgage you already have.
I originate mortgages for a living.
But that doesn't mean I believe every homeowner who can refinance should refinance.
There are circumstances where I may recommend keeping the mortgage you already have.
For example:
If the break-even period is too long relative to how long you expect to keep the mortgage, refinancing may not make sense.
If your existing mortgage has a rate that's significantly better than today's alternatives, replacing it deserves careful consideration.
Spending thousands of dollars on a mortgage you expect to keep only briefly may not be worthwhile.
A lower payment achieved primarily by dramatically extending repayment may work against your financial goals.
Large discount points can create a very long break-even period.
If you're refinancing solely to eliminate PMI, for example, let's first determine whether the PMI can be removed from the existing loan.
Sometimes after running the comparison, the conclusion is straightforward:
Keep the mortgage you have.
I'll tell you that.
Before refinancing, I want to know:
What are we trying to accomplish?
A good refinance should generally have a clear objective.
That might be:
Lowering the interest rate
Reducing the monthly payment
Shortening the mortgage term
Accelerating principal reduction
Eliminating mortgage insurance
Converting an ARM to a fixed rate
Accessing equity
Consolidating expensive debt
If we can't clearly identify what the new mortgage improves, we should question why we're doing it.
When I evaluate a refinance, these are the numbers I want to see side-by-side:
Current balance
Current interest rate
Current payment
Remaining term
Mortgage insurance
New loan amount
New interest rate
New payment
New loan term
Actual closing costs
Lender credit, if any
Then I want to calculate:
Monthly savings
Break-even period
Principal balance after several years
Effect of extending or shortening the term
Expected time in the mortgage
That's a much more meaningful analysis than simply saying:
“I can lower your rate.”
When practical, I like borrowers to see more than one rate-and-cost structure.
For example:
Lower rate
Higher upfront cost
Moderate rate
Lower upfront cost
Higher rate
Lender credit covering eligible closing costs
Then you can decide which option best fits how long you expect to keep the mortgage.
There isn't one structure that's automatically best for everyone.
There isn't a universal rule saying you should refinance only once.
A homeowner could refinance more than once when it makes financial sense and applicable requirements are satisfied.
That's another reason I pay attention to closing costs.
If market rates are declining, paying substantial points for today's refinance could be questionable if there's a realistic possibility that you'll refinance again before recovering those costs.
A lower-cost or zero-cost structure can sometimes provide more flexibility.
You don't need to know whether refinancing makes sense before contacting me.
That's what the analysis is for.
If you provide the basic information about your existing mortgage, I can compare it with current available options.
I can show you:
Current vs. proposed interest rate
Current vs. proposed payment
Closing costs
Lender credits
Break-even period
15-year vs. 30-year options
Principal reduction
Cash-out options, if applicable
Then you can decide whether refinancing is worth pursuing.
Capital Funding Mortgage Associates is an independent mortgage broker based in Newtown, Bucks County, Pennsylvania, serving homeowners throughout Pennsylvania and New Jersey.
Because we're a mortgage broker, we're not limited to the products and pricing of a single bank.
If you're wondering whether refinancing makes sense, I'm happy to review your existing mortgage and show you the available alternatives.
And if I don't believe the numbers justify refinancing, I'll tell you that too.
You don't need to apply for a mortgage just to ask me to run the numbers.
Owner, Capital Funding Mortgage Associates
Mortgage Professional Since 1999
NMLS #960139
REQUEST A REFINANCE ANALYSIS →
COMPARE REFINANCE OPTIONS →
CONTACT JOHN →
John Madden is the owner of Capital Funding Mortgage Associates, an independent mortgage broker based in Newtown, Bucks County, Pennsylvania. John has been helping homebuyers and homeowners with mortgage financing since 1999 and serves clients throughout Pennsylvania and New Jersey.
