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When To Refinance Your Mortgage With Lower Interest Rates

When To Refinance Your Mortgage With Lower Interest Rates

Financing the purchase of the home means carrying a mortgage for between 15 and 30 years. This is a long time horizon and rarely do finances stay the same. Personal finances can change from a loss of employment to getting married while macroeconomic finances mean variable interest rates and supply and demand fluctuations. All of these factors and more taken together mean sometimes the time will be right to refinance your mortgage with lower interest rates. Understanding when it is appropriate to refinance and what it means to your financial situation is paramount.

Breaking Even

The rule of thumb when refinancing a mortgage with a lower interest rate is that the new interest rate should be 1.5% to 2% less than your existing interest rate. There are a number of reasons for this but it primarily has to do with offsetting the $3,500-$4,500 spent in refinancing costs with increased savings from lower interest rate payments. For example, if it takes four years to make back in interest savings what was spent in refinance costs then that is the breakeven point. If the home is sold prior to this date then more money will have been spent refinancing than what was saved and any time after that the additional interest savings is a net positive.

Restarting the Clock

Depending on a home owners' goals, refinancing costs may not be the overriding consideration in this decision. For many families with limited budgets, what is spent on closing costs is less important than a significantly lower monthly mortgage payment. If a family is five years in to their current 30 year mortgage at $1,200 per month with a 6.5% interest rate, they may consider refinancing to another 30 year mortgage but at a lower 4% rate. All other cost considerations are unimportant if it means shaving $300 off of a monthly mortgage payment. In these situations, it is common for the closing costs to be rolled into the new mortgage to avoid having to pay thousands of dollars once the refinancing is complete.

The 15 Year Mortgage

Other individuals actually anticipate and look forward to a higher monthly mortgage payment. A common technique when mortgage interest rates are at all-time lows is to refinance a 30 year mortgage at 7% to a 15 year mortgage at 3.5%. The primary purpose of spending thousands of dollars to possibly increase your monthly mortgage payment is that significantly less interest is paid over the life of the loan. It's possible to see a $1,000 monthly mortgage payment increase to $1,100 but the benefit is that a 15 year loan will often result in saving $50,000-$70,000 in interest expense. This is only possible with historically low mortgage interest rates.

No Free Lunch

When interest rates are at all-time lows, refinancing becomes the thing to do for many home owners. You often hear stories of the home owner refinancing their property four times in five years. Frankly, this is ridiculous and a waste of money but like any other activity some people become addicted to the chase. Often, less reputable mortgage lenders will come out of the woodwork offering refinancing opportunities with no points and no fees. Do not fall for this since consumers tend to pay more on the total mortgage since points and fees are rolled into the outstanding balance. Deal with traditional lenders such as banks and credit unions to get good rates at reasonable terms if you plan to refinance your mortgage.

Image by: Alison and Fil