Refinance: When Does It Make Sense and How?

With mortgage rates at or near record lows, many homeowners with mortgages should analyze whether refinancing makes sense. If you have a 30-year fixed-rate mortgage above 3.5%, you should run a break-even analysis to determine if it makes sense to refinance. 

While you can refinance and save money on a monthly basis, sometimes the monthly savings won’t save you money over the entire course of the loan. 

We’ll explore how to shop around for the best refinance rates, how to run your own calculation to see if makes sense for you, and detail the refinance process.

Before we get started, look at the chart below to see how the 30-year fixed-rate mortgage average in the United States changed throughout time. The cost of borrowing has gone down significantly. I am still amazed banks are lending money for 30 years at 2.5%. 

30-Year Fixed Rate Mortgage Over Time - When Does it Make Sense to Refinance

When Does it Make Sense to Refinance?

Many people approach a refinance simply by saying, “If my monthly payment goes down and I can save money on a monthly basis, it makes sense.” Unfortunately, this is the wrong way to look at it. And even more unfortunate, many calculators online do not tell you the whole picture. Some only look at the savings in monthly payment. 

I like this refinance calculator.  

However, there are others:

With the calculator I like, you input your current loan balance, monthly payment (only principal and interest – do not include taxes and insurance if you use an escrow account), and interest rate. Then, you enter the potential new loan term, new interest rate, and estimated closing costs. Finally, the calculator shows you the difference in monthly payment, remaining interest, remaining total, and the mortgage payoff date. 

When I first bought my house, I had a 30-year fixed mortgage at 3.75%. I thought rates would never go lower. It felt like an amazing deal! 

The economy changed, and I refinanced to 3.05%. Again, I thought it was an amazing rate. Of course, it was at the time. Then, the pandemic hit, the economy got worse, and the Federal Reserve lowered rates. Over time, mortgage rates have come down.

I am in the process of refinancing into a new 30-year fixed mortgage at 2.375%. How did I decide to refinance from 3.05% to 2.375%? I ran the numbers. 

Although many people say to refinance if you can obtain a rate of more than one percentage point lower than your current rate, it depends on your individual circumstance. 

You can see my analysis below. Since I recently refinanced, I still have about 29 years left on my loan. As you can see, the closing costs, the amount you need to pay as part of the loan process, are reasonable (about $2,500) and the difference in payment is $217.05 per month. In about 12 months, I will break even by refinancing. Although I will extend the loan out by a year, I will still save money overall. 

Mortgage comparison

Long-term, I will save a substantial amount of money. If I hold the loan for 30 years, my interest is reduced by $52,245.33. 

My case was easy. I plan to be in the home for longer than a year. After that point, I start recognizing the savings by refinancing. 

There are several situations that make it harder to determine if refinanacing will save money. 

For example, if someone took out a 30-year fixed loan about 9 years ago at a rate of 4%, had a current loan balance of $350,000, and the principal and interest payment was $2,100, they only have 21 years left on their loan. 

Mortgage comparison

If they refinanced into another 30-year fixed loan at 2.875%, they would pay 30 more years of interest and since interest is front-loaded at the beginning of the loan, they actually end up paying more over the course of the loan. 

Although their monthly payment goes down by $637.50 a month, they will actually pay $12,260.91 more by refinancing and have 30 years of more payments. 

As with any financial decision, it’s personal. Some people may not want to pay a cent more than necessary and choose not to refinance. Others may be okay with the additional interest if it means more than $600 in extra cash flow right now. 

Either way, it’s important to understand how the decision will affect you. 

Going further with the last example, perhaps that same person decided they did not want to pay more interest, but would be open to a slightly higher payment to significantly reduce the amount of interest they pay by going into a shorter loan. 

They look into a 15-year fixed mortgage loan and determine they can get an interest rate of 2.25%. In this scenario, their monthly payment increases by $209.17 per month, but they end up paying off their loan six years earlier than planned (going from 21 years left to a new 15-year loan), and reduce the interest they pay by $98,586.37. 

Mortgage comparison with 15-year fixed loan

This is a good example of how people today with higher rates, but farther into paying off their 30-year fixed mortgage loan may benefit from going into a 15-year loan. In some scenarios, they may keep the payment about the same, but knock a few years off the loan and a tremendous amount of interest. 

Another reason to refinance could be to take money out of your home. Many people may be considering a remodel within the next few years. By refinancing, they can pull money out of the house to pay for the remodel.

For example, if you had a loan of $350,000 and wanted to do a $50,000 remodel, you may want to refinance for a $400,000 loan. You would receive $50,000 and have a new mortgage of $400,000. It can be a good alternative to other financing sources because you may be able to borrow $50,000 at 3% with your new loan instead of obtaining a separate loan at a higher rate, such as 5%. Since your mortgage is backed by an asset (your home), you often can obtain lower rates than other loans. This only works for people who have built up enough equity and feel comfortable increasing their debt. 

Refinancing does not make sense for everybody. You’ll need to compare your current loan against other loan options and how long you plan to stay in the home to determine if refinancing makes sense for you. 

How to Shop Around for the Best Refinance Rates

Refinancing is not an easy process, but it could potentially save you tens or hundreds of thousands of dollars over the life of your loan. 

Please spend more time on it than any other purchase. How much time do you spend reading reviews before buying a new cell phone, car, or new laptop? The most you can save shopping around is anywhere from a few hundred to thousands of dollars with those purchases. The potential savings is much higher with a refinance.

It’s tempting to go with the first place you receive a quote, but that may not be the place that can save you the most money. For example, rates can vary by more than one percentage point between lenders. 

Imagine if you were refinancing and found a lender willing to lend you $400,000 at 3.5% for 30 years. You are ecstatic because it will save you a couple of hundred dollars per month relative to your current loan. Now, imagine your friend in the same exact situation spent 30 more minutes comparing quotes with other lenders. They found the same $400,000 quote for 30 years, but at a 2.5% rate. 

The difference in payment between you and your friend is $216 a month. Over the course of the year, your friend will have $2,592 more. They can spend it on home repairs, save for retirement, or splurge on themself.

I know shopping around and getting multiple quotes is not fun, but it is a ton of money on the line. Take the time to fill out quotes, call lenders, or scour the internet. The Bogleheads have a great mega thread. People ask questions, share current rates, and give examples of their situation. 

Nerdwallet also has a great way to compare. By entering your credit range, zip code, property value, mortgage balance, and loan term, you can see multiple rates from different lenders. Please keep in mind these may not be the best lenders for you, but it does allow you to see multiple quotes in one place, which is convenient compared to contacting five different lenders. Below is an example.

Nerdwallet refinance comparison

As you shop around, pay special attention to fees and points. You want to ensure you are making an apples-to-apples comparison among lenders. I generally like shopping around without points baked into the loan. Points are fees paid to the lender in exchange for a reduced rate. It is often called “buying down the rate.” One point is one percent of the loan. For example, if your loan is $100,000, one point would be $1,000. 

If you plan on staying in your home for a long time, paying points can be beneficial as it means you are paying less interest over the life of the loan. If you are only planning on staying in the home for a few years, it may not make sense to pay the points as you are paying more money upfront and may not realize the savings of the reduced interest rate. 

Each situation is unique. You’ll need to compare the mortgage payment from the same lender if you pay points or no points. Then, you can run a break-even analysis to determine if paying more money upfront will benefit you. For example, if you had a $300,000 loan and paid one point, you would pay $3,000. If you could obtain a 3% rate without points and a 2.75% rate with points, the mortgage payments would be $1,265 and $1,225, respectively. The monthly savings by paying points is $40. Since the annual savings is $480, it would take a little more than six years to break even ($3,000 divided by $480). If you planned to stay in the home seven years or more, paying points makes sense. 

Although it is important to compare the difference in rates, fees are also important to compare.

Fees you may pay during a refinance include: 

  • Appraisal (if you have enough equity in your home, sometimes you can ask them to waive the appraisal – often saving around $500)
  • Credit report
  • Title insurance
  • Title settlement 
  • Recording 
  • Lender origination 
  • Flood certification

You may also need to establish a new escrow account and be required to pay 3-12 months of property taxes and homeowners insurance premiums. These are things you would have needed to pay anyway, which is why I don’t include them as a fee. 

Something to be aware of is 15-year and 30-year mortgage rates generally go up or down depending on the yield of the 10-year Treasury bond. If you see yields go down, mortgage rates may fall. If you see yields go up, mortgage rates may go up. However, lenders also increase or decrease rates depending on demand and capacity to take applications. 

For example, the lender I am refinancing with has bounced between 2.375% and 2.5% in the past week. Rates change on a daily basis, which means if you find a rate you like, you may want to lock it as soon as possible. I’ll talk about this more in the next section. 

There is no easy to way shop around for the best refinance rates. It takes work and dedication. In the end, it’s worth it knowing you spent the time trying to find the best rate possible. 

What is the Process of Refinancing?

Let’s get this out of the way – refinancing is not fun. It’s not as bad as buying a home, but it is not a walk in the park. 

You’ll need to go through the application process to lock your rate, authorize a hard credit pull, provide many financial documents, and sign paperwork.

Most people loathe the paperwork. You’ll need to dig up similar paperwork as you did when you bought a home, including:

  • W2s
  • Pay stubs
  • Bank statements
  • Investment statements
  • Tax returns
  • Employment details
  • Current mortgage statement
  • Homeowner’s Insurance policy

Once you submit your application and your credit is pulled, you can usually lock the rate. You don’t need to lock the rate, but as I mentioned earlier, rates fluctuate on a daily basis. If you find something you like that works with your finances, you may want to lock it. This means as long as you close on time, you will receive the rate they offered. If you don’t lock the rate, your loan will close at whatever market rates are at closing. This could be higher or lower. 

If your lender has a good digital process, the application and uploading documents may take 30-60 minutes. Much of it depends on how quickly you can download everything and how many accounts you have. As they review the information, they may request more documents. 

Once everything is uploaded, it goes to the underwriting team. This can take a couple of weeks. They may order an appraisal to ensure your home’s value is high enough to qualify for the loan. 

Once everything is in order, you will wire the closing costs and sign documents to close on the loan. Always verbally confirm wire instructions with your lender prior to wiring funds. Unfortunately, every year people are scammed out of money through mortgage wire fraud. 

Most refinance loans close within 30-45 days, though sometimes it can take longer. 

Summary – Final Thoughts

With interest rates at or near record lows, it is a great time to consider refinancing. While refinancing is not for everyone, you can decide in under 30 minutes if it makes sense to explore it further.

Those 30 minutes could potentially save you tens or hundreds of thousands of dollars over the life of the loan. In my case, I’ve saved a few hundred dollars per month by refinancing twice in less than two years. 

To see if it makes sense for you, plug your situation into a refinance calculator and weigh how long you will be in the home. Also, consider if you want to do a cash-out refi for a big purchase. 

Like any other major purchase, spend time comparison shopping. Your current lender may not have the best rate. Your friend’s lender may not have the best rate. Try to compare quotes from at least five different lenders before doing a full application. If you find one you like, look at options to pay points and whether it makes sense for you. From there, consider locking the rate. 

Once you submit an application, upload and respond to requests as quickly as possible to increase the likelihood you close quickly. 

Good luck refinancing! If you save money by refinancing, I would enjoy hearing your story.  

Disclaimer: This article is for general information and educational purposes only and should not be considered investment, financial, legal, or tax advice. It is not a recommendation for purchase or sale of any security or investment advisory services. Please consult your own legal, financial, and other professionals to determine what may be appropriate for you. Opinions expressed are as of the date of publication, and such opinions are subject to change. Click for Full Disclaimer

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