If You Bought a Home in 2022, Should You Refinance in 2023?

Mortgage rates are well below the highs -- is refinancing worth it?

Mortgage rates are getting lower. The average 30-year mortgage rate peaked at 7.08% in November 2022 according to Freddie Mac, but has fallen to 6.09% as of early February.

While this is still much higher than the 3% mortgage rates common in 2020 and 2021, this is a significant drop. In fact, it's so significant that refinancing could already make sense for many people who bought in the latter months of 2022 when rates were near the peak. Here's a quick guide that can help you determine whether refinancing your mortgage might be a smart option.

How to know if refinancing is worth it for you

I'll try to keep the mathematics here as light as I can. But the best way to know whether refinancing your loan makes sense for you is to crunch some numbers. And there are two basic steps.

Step one is to find out how much refinancing will cost. Your new loan will have closing costs such as origination fees, document prep fees, and more. On average, you can expect to pay 1% to 3% of your loan amount, with the average borrower paying about $5,000 according to Freddie Mac.

Step two is to calculate your savings from refinancing. First, figure out how much you'll save each month by subtracting your new mortgage payment from your current one. Then, multiply this amount by the number of months you are reasonably certain you'll stay in the house. In other words, if you think there's little possibility of you moving within five years, multiply by 60.

If the result from step two is significantly higher than the amount from step one, refinancing can make a lot of sense.

Example of refinancing the right way

For example, let's say you bought a house in late 2022 and used a $350,000 mortgage loan at 7% interest, which gives you a monthly payment of $2,329 (principal and interest). A mortgage lender offers to refinance your loan at 6.25%, lowering your monthly payment to $2,155. Closing costs for the loan are estimated to be $6,000 and you plan to stay in the home for at least five years.

Your monthly savings from refinancing will be $174 in this simplified hypothetical example, so over the course of five years (60 months), you can expect to save $10,440.

In a situation like this, refinancing can certainly be a good option if you plan to be in the home long term. And it's also worth noting that closing costs are generally not paid out of pocket but are rolled into the loan in most refinancing transactions. For example, when I refinanced in 2020, my loan balance went from $288,000 to about $292,000, and the math still worked out very much in my favor with a lower rate.

A one-way renegotiation

One of the most common objections to refinancing that I've heard recently is something to the effect of "well, if I refinance now and rates drop even more, I'll be out of luck."

Nothing could be further from the truth. There's no rule that says you can't refinance again if rates fall even further, especially if the math discussed here works out in your favor. It's true that some banks won't refinance you again within a certain time period (six months and a year are common), but you can always explore your options with other lenders.

As a final thought, refinancing is why legendary investor Warren Buffett thinks mortgages are such an excellent financial tool for Americans. In fact, Buffett has called a 30-year mortgage "the best instrument in the world." The reason? "It's a one-way renegotiation." In other words, if rates drop, you can choose to refinance. And then refinance again. But if rates rise, your rate is locked in for 30 years.