What are the minimum mortgage rates for refinancing?
- Unfortunately, there is no one-size-fits-all answer to this question
- Because no two loan (or homeowner) scenarios are the same
- You should take into account the details of your current home loan as well as the old versus new rate
- Future plans/financial goals/expected length of time in the home, etc.
If you’ve considered refinancing your mortgage, you may have looked up the “refinancing rule of thumb” to help you make your decision.
Funnily enough, there is not just one rule for refinancing. There are many of those existing.
Before we get into it, it’s worth noting that the rules tend not to work universally because there is a long list of reasons to refinance a mortgage.
What works for one person may not work for another, and if you rely on some kind of shortcut to make a decision, you may end up shortchanging yourself in the process.
However, let’s take a look at some of these “refinancing rules” to see if there are any ideas we can use to our advantage.
Refinance only if the new mortgage rate is 2% lower.
- Some say you should only refinance if you can get a 2%+ lower rate
- This is definitely not a rule to live by and is ultimately very conservative
- It is possible to save a lot of money with less than 1%.
- There are also other reasons to refinance that don’t always depend on the interest rate
One common refinancing rule states that you should only refinance if the new interest rate is two percentage points lower than your current mortgage interest rate.
For example, if your current mortgage rate is 6%, this rule will tell you to refinance only if you can get a rate of 4% or less.
But obviously this rule is too broad, just like any other rule. When it comes down to it, the decision to refinance will be unique to you and your situation, not anyone else’s.
This old rule assumes that most mortgage loan amounts are very small, unlike the jumbo loans we see these days.
The thought may be that the closing costs associated with refinancing could outweigh any potential savings. Chances are that this is not true.
[How to lower your mortgage rate without refinancing.]Is it worth refinancing your mortgage at a lower rate of 1%?
Let’s look at some basic math to explain why the 2% refinancing rule fails, and how a lower rate of just 1% (or less) can be so beneficial:
Loan amount: $500,000
Loan type: 30-year fixed-rate mortgage
Current mortgage rate: 7% ($3,326.51 per month)
Mortgage refinance rate: 6% ($2,997.75 per month)
Refinancing cost: $4,000
In this hypothetical scenario, the current mortgage payment on a $500,000 loan at 7% is $3,326.51.
If you refinance to 6%, your monthly mortgage payment drops to $2,997.75. Sounds like it might be worth refinancing…
That’s a difference of about $330 per month, which will certainly make it easier to meet your mortgage obligations. Or simply to allocate savings elsewhere.
However, there is a $4,000 refinancing cost to consider (let’s not ignore closing costs).
However, it will only take a little over 12 months to recoup the cost of refinancing ($4,000/$330). It’s actually less time if you take into account the increased stock accumulation thanks to the lower interest rate.
However, the “break-even period” for refinancing (the time needed to recover the upfront closing costs) is very short here. Therefore, we do not need to follow the “2% lower interest rate” refinancing rule.
In fact, even a rate decrease of just 0.50% (from 3.5% to 3%) would result in a monthly savings of about $140 and take less than two years to recoup.
[See all the top refinance questions in one place.]Pay attention to refinancing fees, especially with smaller loan amounts
But what if the loan amount is only $200,000? The game changes quickly. Your mortgage payments will decrease from $1,330.60 to $1,199.10.
That’s a monthly savings of about $130, which isn’t very much, especially if refinancing is still costing you thousands.
Assuming the cost of the mortgage remains in the $3,000 range, it will take about 23 months, or nearly two years, to recover the costs associated with refinancing.
If you’re thinking about selling your home in the short term, it probably won’t make sense to spend money to refinance.
That’s probably why this old refinancing rule exists. But home prices (and loan amounts) are much higher these days, so it’s not a good rule for everyone to follow.
The same goes for any other mortgage rate rule that states your interest rate should be 1% lower, or 0.5% lower.
Whether or not this is appropriate really depends on a number of factors, such as the loan amount, closing costs, and expected tenure in the home.
If we don’t know the answer to all of these questions, we can’t come up with some universal rules for everyone to follow. Again, don’t cut corners or you may find yourself in a worse financial situation.
[Check out these mortgage payment tables to quickly eyeball differences in rate, or use my refinance calculator to run your own simulation.]advice: Pay close attention to the closing costs associated with the loan. Just looking at the price and paying is not good enough.
Only refinance if you will save “X” dollars each month
- This blanket refinancing rule fails to take into account interest savings
- The decision may have nothing to do with your monthly payment
- There are other benefits to refinancing aside from paying less each month
- Such as faster buildup of home equity and shorter loan term (possibly due to retirement)
Another rule of thumb for refinancing is to only do so if you’ll be saving “X” dollars each month, or only if you plan to live in your home for “X” years.
Again, as we saw in our example above, you can’t rely solely on a blanket rule to determine whether refinancing is a good idea.
Some borrowers may need to stay in their home for five years to save money, while others may need to stay in their home for a little more than a year.
But plans change, and you may find yourself living in your home longer (or shorter) than expected.
And if you look at refinancing savings in dollar amounts, it will really depend on the cost of refinancing and how long the new payment will be.
If it’s a no-cost refinance, which is always a popular option, you won’t have to worry about the break-even period.
There are also homeowners who simply want payment relief, even if it means paying more in interest in the long run.
Others may want to refinance into a shorter-term mortgage, perhaps to pay off their loan before retirement, even if it increases their payments in the process.
So it would be foolish to get involved with this rule unless you have a bulletproof plan. Let’s face it, no one does.
[Does refinancing hurt your credit score?]Forget the rules, think about the term and type of loan
- The length of your mortgage (and type) can be a big part of your refinancing decision
- Consider the remaining loan term and the type of mortgage you will be refinancing
- Plus how long you plan to keep the new loan after refinancing
- Also consider your future plans (move, stay, or keep the property to rent out?)
Finally, consider the length of your mortgage when refinancing, and the total amount of interest you can avoid paying over the life of the loan.
If you currently have five years on a 30-year fixed mortgage, and refinancing to a 15-year fixed mortgage, you will save 10 years on your total mortgage term.
Assuming mortgage rates are low enough at the time of refinancing, you may end up with a lower monthly payment despite the shorter term.
You’ll also build capital faster and significantly reduce the total interest paid, which will shorten your break-even period and maximize your savings.
[30-year mortgage vs. 15-year mortgage]If you simply refinance into another 30-year loan, you must take into account the five years in which you have already paid interest when calculating the refinancing interest.
Those who have been paying their mortgage for a decade or more may not want to restart the clock at 360 months, even if mortgage rates look too good to pass up.
Also consider your current loan type versus what you plan to refinance into.
If you currently have an adjustable-rate mortgage that will reset higher soon, the decision to refinance may be more pressing.
Take the time and do the math before you decide
Ultimately, you shouldn’t use any rule of thumb to determine whether or not you should refinance.
It’s a lazy thing to do, especially when it’s not that hard to run some numbers to see what would make sense for your particular situation.
If you’re feeling overwhelmed by all the calculations, ask a friendly loan officer or mortgage broker to run some scenarios for you to illustrate potential savings and break-even periods.
They have the tools at their fingertips to quickly generate different results by simply plugging in a few numbers.
Just make sure they are giving you an accurate and complete picture and that they are not motivated merely by salary. Data can be manipulated in many ways.
As mentioned earlier, you can also check out my mortgage refinancing calculator on this website to run the numbers yourself.
Either way, take your time — you’re not shopping for a big-screen TV, you’re making one of the biggest financial decisions of your life.
The return on investment can be huge if you do it right.
advice: When to refinance a home loan.
(picture: Engerman)
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