Rules of thumb are often referred to when discussing financial issues. One of those that is particularly relevant right now is related to refinancing. It goes, “if you can reduce your mortgage rate by 1.0% then you should refinance.” I think it is time to update this rule and reduce that to, “if you can reduce your mortgage by 0.50% you should consider refinancing.”
My wife and I are in the process of refinancing our mortgage. We are reducing our mortgage rate by 0.65% which is going to reduce our monthly mortgage payments by 16.5%. With rates under 3.0%, I recommend considering a 30-year, fixed mortgage. A 30-year mortgage provides lower payments which gives you flexibility to save or invest the savings or to make extra payments when you decide to do so.
While the reduction in our mortgage payment is substantial, it is not the only thing to consider when refinancing. When you evaluate refinancing you must quantify all the costs which include appraisal fees, loan costs, and recording costs. Dividing the total expenses related to refinancing by your monthly savings will give you the breakeven time in months to recoup refinancing expenses. Obviously the lower the number the better, but if the breakeven is 12 months or under, refinancing makes sense. The breakeven for our refinancing is 7 months so it was a no brainer to refinance. During the refinancing you will have the option to roll your costs into the new loan or pay them directly. I always recommend paying them directly otherwise you will pay interest costs on these expenses over the life of your loan which reduces the overall benefit.
Of course, everyone’s situation is different, so it helps to discuss yours with a financial planner or a CPA to make sure you have considered all the relevant information.