When to Refinance?

Mortgage rates are on the rise. As reported by the New York Times, rates jumped 50 basis points virtually overnight. My own tracking of rates confirms the jump, as reflected here. And this raises an important question–when should you refinance a mortgage?

The common reason to refinance a mortgage is because rates have gone down. This in turn raises the question of just how much lower rates must be to justify the refi. We’ll answer this question below, and look at three other good reasons to consider a mortgage refinance.

Interest Rates Have Gone Down

The primary reason many homeowners refinance their mortgage is to lower their interest rate. It’s why we refinance just about any loan, whether it’s a mortgage, student loan, or even credit card debt (think 0% balance transfer cards). According to the White House, the average homeowner could save $3,000 a year by refinancing their mortgage.

As you evaluate whether lower rates justify refinancing, consider the following:

While rates have ticked up, predicting future interest rates is a fool’s errand. Most predict that rates will rise over the coming months and years, and I agree with this assessment. I also thought the Indians would win the World Series. The point is that you should evaluate whether to refinance a mortgage based on today’s rates, not a prediction of future rates.
How much you’ll save each month is a function of more than the interest rate. Mortgage brokers often tout the lower monthly payment, but keep in mind that the lower payment is also a function of the term of the new loan. If you have 20 years left on your mortgage and refinance back to a 30-year mortgage, the extended term will lower your monthly payment even at the same interest rate.
It’s important to factor in the tax consequences of a refinance. Lowering your interest rate saves money, but perhaps not as much as you may think once you adjust the lower interest payments for the smaller tax deduction.
And that brings us to the question of just how much lower must rates be to justify refinancing. There are numerous “rules of thumb” that range from 0.50% to as high as 2%. A better approach is to do the math. It takes just a few steps: