When to Refinance a Mortgage with Lower Interest Rates

Mortgage rates are at record lows and banks are holding huge cash reserves waiting for well qualified borrowers.  Although there is no guarantee, all signs point to an end for the current interest rates in the years ahead.  If and when inflation starts to pick up, there will be pressure to start easing interest rates up to avoid run-away inflation.  So, when is it time to refinance to grab those rates?

The first hurdle to clear is a quick check to make sure that the refinance will truly qualify for the low rates.  Although there is no shortage of banks clamoring that now is the time to refinance, they rarely mention that the rates you see advertised usually only apply to borrowers with very good credit.  In a reaction to the mortgage scare, banks tightened their lending standards (probably back to where they should have been all along).  Yes, there are record low interest rates these days, but borrowers who are not prime credit risks will not be able to take advantage of those rates.

The next hurdle: make sure you have equity in the home.  Assuming that a homeowner can get the lower rates and qualify for the loan, lenders will want to be sure that they are not about to find themselves holding loan papers that outweigh the home value.   A significant percentage of homeowners are currently upside-down on their homes – owing more than the home is now worth.  Another hard learned lesson from the last few years is that when owners find themselves making payments on a loan that is more than the value of the house, they tend to walk away and stop paying, even if they can make the payment.  Banks will not come to the table for a refinance if the new loan will keep you upside-down.  If you are one of those ten to thirty percent who owe more than the home is worth, this is probably not the right time to be looking for a refi.

If you are sure that you will qualify for the lower rate, and sure that you will be able to refinance, then it’s time for some math.  Start with a very honest evaluation of how long you intend to live in the home.  The longer you intend to live in the home, the more time that the new lower rate will be helping you save money.  Next, survey your potential mortgage companies to find out the costs of the refinance.  Many banks will charge various fees to complete the refi, such as appraisal costs, loan application fees, closing fees and title costs, points, and perhaps even home inspection costs.  Your potential savings will need to cover these up front costs to make a refinance make sense.

Then, calculate what you will save with the new lower rate.  Make sure that you not only account for the lower payment that you might get, but also account for the fact that with a lower interest rate you will be paying more toward principal with each payment.  (Especially if you can lower your rate and reduce the term of the loan.)  You can find calculators online that will help you determine these numbers.

Your bottom line: if “A” represents your up front costs to refinance, “B” is the difference between your current monthly payments and new payments, “C” is the increased principal pay down that you will get with the refi, and “D” is the number of months that you reasonably expect to stay in the home, now is the time to refinance if: A < (B + C) * D