With mortgage interest rates near record lows, it might be tempting to refinance your mortgage, especially with many experts predicting that rates will begin to rise later this year. After all, if you bought your house more than a couple years ago, chances are you're paying much more than the current market rates.
However, even though refinancing can definitely lower your mortgage payment, there are other costs to consider. Is refinancing a good move for you? The short answer is that it depends.
When it makes sense to refinance
When considering refinancing, you need to look at two numbers -- the amount you'll save on your monthly payment and the amount it will cost you to refinance the loan.
Basically, to justify refinancing, the benefits need to outweigh the costs. When you refinance your mortgage, you'll have to pay a variety of closing costs and other fees. By dividing the amount of these costs by the difference in the monthly payments, you can determine how long you'll need to stay in your home before refinancing becomes worthwhile.
In other words, refinancing could be the right move if you're going to keep your home long enough to justify paying for the process.
What it costs
So what are these closing costs? Here's a list of some typical expenses you might incur when refinancing, according to a guide from Nationwide:
- Mortgage application fee ($250-$500 is common)
- Origination fee (about 1% of the loan amount)
- Document preparation fee ($200-$400)
- Appraisal fee ($300-$700)
- Title examination ($150-$450)
This is by no means an exhaustive list, and there are many location- and lender-specific requirements satisfy when refinancing. For example, if you live in a flood-prone area, your lender might want to see an elevation certificate for your property. You should check with a few lenders to determine what additional costs to expect.
Let's say you obtained a $250,000 30-year mortgage five years ago at 5% interest, and your monthly payment (principle and interest) is $1,340. According to an amortization calculator, the outstanding balance on this loan would be just over $229,500 if you only made the scheduled monthly payments.
If you refinance the loan, you can expect to pay about $4,000, using the midpoints of the typical closing cost amounts listed above. If your refinanced loan comes with a 4% interest rate, you can expect your monthly payments to be right around $1,100.
Dividing $4,000 by $240 (the difference in the two payments) gives us about 17 months before you break even on the closing costs. In this case the breakeven time frame is pretty small, so refinancing could be a good idea for you. If your current interest rate is closer to the rate you could obtain when refinancing, though, the breakeven time can increase dramatically.
Also worth considering if you refinance into a new 30-year loan is that the payback clock would start over. In other words, the hypothetical borrower in the above example would have had just 25 years left on the original loan. Refinancing adds another five years of payments.
Before deciding to refinance, you should perform a similar analysis to determine whether it's worth it for you. If you are reasonably confident that you'll stay in your home longer than it takes to make up for the cost of refinancing, it could be a good option to consider.
Shop around before you crunch the numbers
Before you decide whether refinancing is the right move, make sure you shop around for the best deal possible. Remember that the further apart your current and new interest rates are, the more likely it will make financial sense to refinance.
You should get quotes from several lenders to compare not only the rates, but the fees as well. As long as you do your shopping within a short period of time, it won't hurt your credit any more than submitting a single application would, and it could save you thousands of dollars in the long run.
Once you get a few quotes, compare the fees to the difference in payments and decide whether refinancing makes sense for your mortgage.