With home mortgage rates continuing to hover near historical lows, people frequently ask me when they should refinance their home loan. Refinancing, if done at the right time and at the right rate, can save significant dollars over a period of time. However, there are times when it doesn’t make financial sense. Picking the right time takes a little foresight and maybe a bit of luck. Even though I don’t think there is one common solution for every situation, there are several factors that can help provide some perspective.
First, it makes sense to think about how long you plan to stay in your home. If you are in the home where you plan to spend the next twenty years raising a family, it makes more sense to refinance for a smaller drop in rate. If you are in your first home and hope to move in two or three years, the rate drop will have to be more significant for it to benefit you.
Second, consider the closing costs. It typically costs $2,000-$3,000 to refinance your home loan. A general rule of thumb is to think about refinancing when the rate improvement covers your closing costs in a year or two. For a $150,000 mortgage at 6.50%, a ¼% drop in rate to 6.25% saves about $25/month in payment, $376 in interest cost in the first year, and approximately $8,830 over the life of a 30 year fixed rate mortgage. It would take almost eight years for this refinance example to cover $3,000 in closing costs. So at first glance, refinancing for a ¼% savings doesn’t make much sense because the most you will save over 30 years is about $5,830 after covering closing costs. On the other hand, refinancing from 6.50% down to 5.50% is a much different scenario. This 1% drop with everything else being equal will save about $96/month in payment, $1,501 in interest cost in the first year, and approximately $34,711 over the life of a 30 year fixed rate loan. Closing costs will be recovered in the first two years and even if you happen to move in a few years, the savings are still significant.
If you have a larger loan, the savings could be even more drastic and so it may make sense to refinance if the rate drop is less than 1%. If your loan is smaller, the savings will add up more slowly and you may want to see a drop of more than 1% before you refinance.
And finally, refinancing your home at a lower rate may enable you to pay your home off more quickly at a significant savings without more money coming out of your pocket. For example, if you have a $150,000 mortgage at 6.50% and your monthly payment (principal and interest only) is $948, you could refinance your home loan at 5.50% and pay off your mortgage in 23 years instead of 30 for about a $10 increase in your monthly payment. Not only would you pay off your loan seven years more quickly, but you would also save approximately $76,652 in total interest cost. This is a huge potential savings and could help you save for retirement or pay off other debt much more quickly!
Every situation is different and there are other factors to consider. But, if you have a home loan and haven’t thought about refinancing, now is a great time to look at your options. First National Bank has a great team of lenders who can discuss your situation and help you think about the implications of refinancing. Don’t hesitate to call or stop by any of our branches in Bluffton, Pandora, and Findlay to see how much you can save.