Refinance to Lower Your Mortgage Rate
- How Much Lower Should My Mortgage Rate Be When I Refinance?
- A good rule of thumb to follow when refinancing is that the new mortgage rate should be a minimum of .750% lower than your current rate
- Breakeven When You Refinance Your Mortgage
- The breakeven point to recover closing costs when you refinance your mortgage should be no more than 30 months
- Mortgage Refinance Example
- Use our MORTGAGE REFINANCE CALCULATOR to determine how much you can save and time to breakeven by refinancing
One of the most common reasons to refinance your mortgage is to lower your interest rate and monthly payment. Reducing your mortgage rate usually enables you to save money on your monthly payment as soon as your refinance closes. Although it seem like an easy decision, there are closing costs and other expenses that borrowers should keep in mind. The costs of refinancing may outweigh the financial benefits depending on by how much you are able to lower your mortgage rate. A frequent question that borrowers ask is how much lower than my current rate should my new mortgage rate be for me to refinance? What amount of monthly savings justifies the expense that may be associated with refinancing.
In short, it usually makes sense to refinance your mortgage if your new mortgage rate is at least .750% lower than your current rate. So if are currently paying 5.000%, your new mortgage rate should be 4.250% or lower. A reduction of .750% or more allows you to reduce your monthly mortgage payment and typically recover your refinancing costs in 30 months or less. If you reduce your mortgage rate by less than .750%, you still lower your monthly payment but it may take you a long period of time to recover your closing costs, so it may make less sense to refinance.
Closing costs also play a very important role in determining if you should refinance your mortgage. If you pay little or no closing costs, then refinancing usually provides a financial benefit even if you only lower your mortgage rate by a small amount. For example, if you reduce your mortgage rate and lower your monthly payment by $50 without paying closing costs, then refinancing is a sound decision because you can save money without bearing significant expense. It is important to highlight that a no cost refinancing usually charges the borrower a higher rate than if you pay regular closing costs so you should always weigh the trade-off between mortgage rate and closing costs when deciding if you should refinance.
Another point to highlight is that different mortgage programs have different interest rates. For example, the rate for an adjustable rate mortgage (ARM) or interest only mortgage is typically lower than the rate for a fixed rate mortgage. But ARMs and interest only loans involve more risk than a fixed rate mortgage because your monthly payment can potentially increase significantly in the future. So you may be able to lower your mortgage rate and payment in the near term but you may not be able to afford the loan in the long term. Borrowers should weigh the positives and negatives for each type of loan before switching programs to simply reduce your mortgage. Short term savings may end up costing you much more over the course of your loan.
As referenced above, in addition to your mortgage rate, borrowers also need to factor closing costs into their refinance decision. The best way to think about closing costs is to determine how long it takes your mortgage to pay you back if you refinance. You may be able to lower your mortgage payment but if it takes you ten years to recover your closing costs, then refinancing may not be the right option, especially if you plan on selling your home or paying off your mortgage before ten years.
The amount of time it takes you to recover your refinancing costs based on the amount of money you save on your new monthly mortgage payment is called the breakeven point. For example, if it costs you $2,000 to refinance your mortgage and you save $100 per month by refinancing, the breakeven point is 20 months. $2,000 in costs ÷ $100 per month = 20 months. You want the breakeven point to be 30 months or less when you refinance your mortgage.
Borrowers should weigh the benefits of a lower mortgage payment against the costs associated with refinancing. Spending a lot on closing costs to lower your monthly payment a small amount does not make financial sense while a larger reduction in your monthly payment that enables you to recover your closing costs, or breakeven, in a shorter period of time, is beneficial for borrowers.
The example below illustrates how refinancing to lower your mortgage rate can save you money on your monthly payment. For the example below we are holding the mortgage amount constant and assuming that the borrower pays closing costs but does not pay any discount points. By refinancing, the borrower reduces his or her mortgage rate by .750% and monthly payment by $170 per month. Assuming $1,875 in closing costs, which is relatively typical for a mortgage of this size, the borrower recovers refinance closing costs in twelve months.
This example demonstrates both rules of thumb when it comes to refinancing your mortgage. The borrower was able to lower his or her mortgage rate by at least .750% and recover refinance costs in less than 30 months. In this case, it definitely makes financial sense for he borrower to refinance. The more you can lower your mortgage rate, the faster your time to breakeven and the greater the benefit you realize by refinancing.
|Current Mortgage||Refinanced Mortgage|
|Term||30 years||30 years|
|Monthly Mortgage Payment||$2,040||$1,870|
|Number of Months to Recover Refinance Costs / Breakeven||12 months|
|Monthly Mortgage Payment Savings||$170|
|Interest Rate Savings||.75%|
|Monthly Mortgage Savings||$170|
|12 months to recover refinance costs|