Refinancing a mortgage involves replacing an existing mortgage with a new one, typically at a lower interest rate. Depending on your circumstances, refinancing your mortgage can be beneficial and lead to cost savings.
The hardest part is deciding when to refinance, as there are many factors to consider.
When is Refinancing Worth It?
For many people, the default answer to “when to refinance my mortgage” is “ when interest rates go down." However, this isn’t necessarily always the best approach. You’ll need to consider other things while determining whether refinancing is worth it for you. The key question to ask yourself is what financial goals you're trying to achieve.
Say your financial position has recently improved, for example, if you've started a much higher-paying job. In this scenario, despite interest rates having increased, you might still be interested in refinancing your mortgage for a shorter loan term. Although your monthly payments will increase, the total amount you owe will go down due to the shorter loan term.
On the flip side, if you find yourself in a position where you need fast access to cash, you might consider refinancing to extend your mortgage for a longer loan term, or tapping into home equity, which means taking out a loan using your home's worth as collateral. These options will result in a higher amount payable over the life of the mortgage but could provide some much-needed cash.
When deciding whether or not to refinance your mortgage, consider that in 2023, mortgage rates are at a near-decade high. In a high interest rate environment, people are generally less likely to refinance their mortgages because the cost of borrowing is higher.
What is the Ideal Rate Drop for Refinancing?
In terms of interest rate reduction, there's no magic number to wait for before deciding to refinance. However, mortgage professionals recommend that the rate drops by at least 0.75% if your primary reason for refinancing is to get a lower interest rate. Any less than this, and it is likely that any savings will be negligible when considering the closing fees and other costs you'll pay as part of refinancing your mortgage. Depending on the mortgage lender, this closing fee can be anywhere from 2% to 5% of the mortgage balance. You can either pay the closing fee at the time the new mortgage is entered into, or it can be rolled into the overall mortgage amount.
When Does it Make Sense to Refinance?
The following scenarios are all common reasons to refinance:
- Interest rates have gone down: This is the most commonly understood reason for refinancing. The cost of obtaining a mortgage has been reduced; therefore, your monthly payments would be lower with the reduced interest rate. As such, you can save more money each month.
- Your credit score has improved: As with all loans, a better credit score has an impact on the interest rate available. If your credit score has improved since you first obtained a mortgage, you’ll likely have access to better rates, offering the chance to save money on monthly repayments.
- The value of your home has gone up: If your home has increased significantly in value, refinancing can offer the opportunity to tap into the equity in your home. This is a good option if you need lump sum cash or have high-interest-rate loans elsewhere that can be paid off. Yet, it’s vital to ensure that the refinancing doesn’t lock you into a position where interest rates are too high.
- You want to adjust the term of your loan: If your financial position has changed, you can refinance your mortgage for a longer or shorter term. A shorter term will result in higher monthly payments but with lower total payments over the duration of the mortgage. A longer term gives the opposite, saving money on monthly payments now but leading to a higher total cost over the lifetime of the loan.
Why Refinance Your Mortgage?
In short, you should be aiming to either save money, pay off your mortgage faster, build additional home equity, or a combination of all three.
The length of time that you expect to stay in your home also matters. Refinancing makes sense if you can see yourself staying in the property for a long time. However, if you plan to sell your home within a year or two, then refinancing doesn't make much sense, as the closing fee costs will likely eat into any money you could possibly save.
How to Refinance Your Mortgage: A Step-by-Step Guide
If you are considering refinancing your mortgage, follow the below steps:
- Establish your financial objectives. What do you want to achieve through refinancing?
- Check your credit score and compare it with your credit score when you entered into the initial mortgage.
- Compare mortgage rates available in the market against your current mortgage rate.
- Apply for a mortgage with your preferred mortgage provider. Ensure that you check the closing costs and any other fees.
- Lock in your rate. Obtaining a mortgage can take a long time, with an average completion of about 50 days. Locking in a rate ensures that if interest rates rise in this period, your rate is not affected.
- Complete the loan. You can either pay the closing fees immediately, or they will be added to the mortgage. If you can afford to pay the closing fee upfront, it's the most cost-effective option.
Deciding whether or not to refinance requires careful planning. There are many different factors to consider, beyond the fluctuation of interest rates. It's always recommended to work with a professional who can help you make the decision that makes the most financial sense for you.
In today’s environment, where interest rates are rising, the rate on a new mortgage is likely to be higher than the rate on an existing mortgage. However, there are still some situations in which refinancing may make sense, for example, locking in a fixed-rate mortgage before rates go even higher.
Ultimately, deciding whether or not to refinance depends on individual circumstances, such as the current interest rate, your financial situation, and the costs associated with refinancing. It's important to carefully consider these factors before deciding whether or not to refinance.