Determining the right time to refinance

Is refinancing a good choice? There are different factors to think about when choosing to refinance.

Written on updated on

A lot of people wonder when the right time to refinance is. Aiming to reduce your interest rate is a great starting point. There used to be a rule of thumb that if you can recoup your loan costs in less than 5 years, then you should refinance to get a lower rate. However, everyone has different goals and life plans. So what makes sense for one person may not make sense for another. 
Obviously refinancing is not free and there are costs involved. When deciding if refinancing makes sense, you should consider how long it will take you to recoup your loan costs. This is called the "break-even" point. Ask yourself if you still plan to live in your home past the break-even point so that you can actually reap the benefits of a lower interest rate.
You can calculate your break-even point by taking your loan costs and dividing them by how much you would save on mortgage payments per month.
Lets say your total loan costs are about $5000 and you're paying $3100/month now, but after you refinance you will pay $2600/month. That's savings of $500/month.
($5000 ➗ $500) = it will take you 10 months to reach your break-even point.
There are other benefits to refinancing than lowering your monthly payments too. You could shorten the term of your loan and pay off your mortgage faster. You could switch from an ARM to a fixed-rate or vice versa. 
You could also take cash out during your refinance to spend on renovations to increase the value of your home or you can use the money to consolidate your debts. 
Whatever you choose to do, your lender will work with you to figure out what makes sense for you and how to maximize your savings. You just have to ask yourself:
  • What are my goals for refinancing?
  • How much money am I aiming to save?
  • How long am I planning to stay in my home?