How Do I Know Whether Or Not To Refinance My Mortgage?

Mortgage rates have recently been so low that many in the mortgage industry never anticipated they could get so despondent, leaving many wondering whether it is now time to refinance the mortgage (again).

There are a variety of considerations and a few simple answers, but I’ll try to clear away as much confusion as possible to help you determine if you should refinance.

First, you should assess whether your home is worth enough to support the mortgage you want. In order to be eligible for the lowest cost mortgage, your home should be worth about 1.25 times the mortgage. If you make a $200,000 mortgage, your home must be worth $250,000 to get the lowest cost mortgage in terms of interest rates and fees, including mortgage insurance. Generally, you can’t refinance your mortgage at all unless your home is worth at least 1.11 times the mortgage amount. (In some circumstances you can negotiate with your lender to modify your existing mortgage if the home’s value is lower than the mortgage balance and you have had trouble making the payments.)

In order to obtain the best mortgage rates, you’ll need to have very good credit. Satisfactory credit starts with never making any payments late and includes not having too much debt relative to your income. Recent foreclosures, judgments and bankruptcies make refinancing almost impossible for low market rates. You’ll also need stable income; if you’ve had fresh gaps in employment, you may need to wait to refinance. The best way to see that you have good enough credit is to apply.

The difference between the interest rate you’re paying now and the interest rate you’re being offered is also important. Some lenders will do a mortgage refinances at no charge to you, but they charge a higher-than-market interest rate. This could be a big idea if you intend to move in the near future as you’ll have invested nothing (but your time) in the refinance. If you choose a zero cost refinance deal, any interest savings you get will begin immediately. If you are confident that you’ll be staying in your home for a long time, it may be wiser to pay some fees (typically about 2% of the loan balance) to refinance as you should be able to find a lower interest rate than you’d get with a no-fee loan.

If you choose to pay the typical 2% fee to get the best rate, you’ll want to make that up as quickly as possible. If your new rate will be two percentage points lower than your old mortgage, that is your old mortgage is at 6% and the new one will be at 4% or less, then you can make up the cost of the refinance in about a year. If the difference is just one percentage point, it will take about two years. You’ll have to decide what is sensible in your situation, but I wouldn’t refinance to save less than one percentage point.

Bear in mind that there are some things you’ll have to pay at closing that isn’t, strictly speaking, costs of the refinance. Do not forget to plan for things like funding the escrow account for property taxes and insurance and for prorated interest at closing. These are all costs associated with having a home and/or a mortgage and not associated with the transaction, but you may have an obligation to pay pay them sooner than you would otherwise.