Under the right circumstances, refinancing a home loan can be an excellent strategy for long-term savings or to create financial flexibility for significant future expenditures. However, given the constantly shifting market conditions, how can you determine if now is the opportune moment to consider refinancing?
With mortgage interest rates reaching historic lows just a few years ago, many fortunate homeowners secured exceptionally favorable rates. But if you purchased your home when rates were higher and are contemplating refinancing to enhance your financial standing, what key information should you possess? Interest rates are always in flux, and you might be wondering how much rates need to drop for refinancing to become a financially sound decision for you, allowing you to leverage its potential benefits.
What is Refinancing a Home Loan?
Simply put, refinancing is the act of replacing your current mortgage with a new one that offers more advantageous terms. Its purpose is to improve your financial situation as a homeowner. There are numerous motivations for refinancing, but typically, the decision to move forward with a new mortgage boils down to:
- Saving Money: By refinancing when interest rates are lower—even by a single percentage point—you could potentially decrease your monthly payments and save thousands in interest costs over the life of your loan. However, simply reacting to a lower rate might not always be the optimal choice for your specific situation. It’s advisable to consult with your mortgage loan officer to ascertain if refinancing makes sense for you when rates are lower.
- Accelerating Loan Payoff: Perhaps your initial home purchase involved a longer loan term. Now, a few years later, your financial circumstances have changed, and you can comfortably afford higher mortgage payments. By refinancing to a shorter term, you could pay off the loan more quickly, thereby reducing the total amount of interest accrued over time.
- Extracting Cash: Beyond just saving money, refinancing enables you to access the equity you’ve built in your home to fund other aspects of your life. (Consider your child’s college tuition or a wedding, home renovations, a dream vacation, or eliminating credit card debt.) For example, if you owe $180,000 on your $300,000 home and refinance with a $220,000 mortgage, you would be left with $40,000 to cash out and use as you wish.
Determining if it’s Worthwhile: Finding Your Breakeven Point
Interest rates play a significant role in assessing whether refinancing your mortgage is currently worthwhile, but they represent only one factor in the decision-making process.
Generally speaking, it’s more crucial to understand your breakeven point—the precise moment when any financial savings derived from the new loan outweigh the costs associated with obtaining it. Knowing your breakeven point is a key indicator of whether refinancing right now will be beneficial.
Here’s how to calculate your breakeven point:
- Calculate Total Costs: First, you’ll want to sum up all the expenses associated with refinancing your mortgage. This includes fees such as application fees, appraisal fees, origination fees, and any other closing costs. If you are unsure of your potential costs, consult with a mortgage loan officer who can provide a clearer estimate of what to expect.
- Estimate Monthly Savings: Next, estimate how much you will save each month by refinancing. This can be determined by comparing your current monthly mortgage payment to your projected new payment after refinancing. Be sure to account for any changes in interest rate, loan term, or loan type. For instance, are you transitioning from an adjustable-rate mortgage to a fixed-rate mortgage?
- Compute Breakeven Point: Once you have determined the total cost of refinancing and your anticipated monthly savings, you can calculate your breakeven point. Divide the total refinancing costs by the monthly savings to ascertain how many months it will take to recover your upfront expenses. For example, if your refinancing costs are $5,000 and your monthly savings are $100, your breakeven point would be 50 months ($5,000 divided by $100 = 50).
- Consider Future Plans: Now, you should consider your future intentions. How long do you plan to reside in your home? If you anticipate selling or refinancing again within a few years, you might not have sufficient time to recoup the costs involved with refinancing. However, if you plan to stay in your home for a period longer than your calculated breakeven point, refinancing can lead to substantial savings over time.
Your Mortgage Loan Officer can be your most valuable resource, guiding you through the decision-making process of whether refinancing is right for you. They will be available to answer any questions you may have and can walk you through the various options and considerations related to refinancing your mortgage.