Erik J. Martin The Mortgage Reports Contributor
December 7, 2020 – 7 min read
Refinancing your home is personal
For many homeowners, it’s worth refinancing to save $100 per month. Whether that’s true for you depends on a number of factors.
Do you need the extra wiggle room in your budget? Will you stay in the home long enough to “break even”?
Or can you refinance to accomplish another goal, like cashing out your equity or paying off your loan early? In this case, the monthly savings might not matter.
Only you can decide if refinancing your home is worth it based on your circumstances.
The refinance-to-break-even rule of thumb
Refinancing, in general, should save you money over the long term to be truly worth it.
While every situation is unique, one simple way to decide when to refinance is by calculating your “break-even point” — the point at which your refinance savings outweigh your closing costs.
To break even and start seeing real savings, you’ll typically need to stay in the home at least a few years after refinancing.
“But being able to know how long you will be in a home isn’t easy,” says Ralph DiBugnara, founder of Home Qualified.
As a simpler alternative, he suggests “You should aim to recoup your costs in the first 24 months of the loan.”
DiBugnara explains: “Say you end up saving $300 per month after refinancing, but your closing costs totaled $6,000. Here, you would recoup your costs in 20 months. Then, every month after that your savings would continue to multiply.”
Is it worth refinancing to save $100 per month?
Let’s say you check today’s refinance rates, and you estimate a refinance could save you $100 per month on your mortgage payments.
To determine if this refinance is worth it, you have to look closely at your refinancing expenses.
Consider that your closing costs will likely total between 2 to 5 percent of your new loan’s principal balance. On a $200,000 loan balance, that’s a minimum of $4,000 out of pocket.
Saving $100 per month, it would take you 40 months — more than 3 years — to recoup your closing costs.
So a refinance might be worth it if you plan to stay in the home for 4 years or more. But if not, refinancing would likely cost you more than you’d save.
However, the 2-to-5-percent closing cost estimate isn’t in stone. Negotiate with your lender a no closing cost refinance. Your rate might be slightly higher than market rates, but still much lower than your current rate. Read on for more information about these loans.
With the right deal, you could start saving within months, not years.
Is it worth refinancing for a 1% lower rate?
Erik Wright, owner of New Horizon Home Buyers, suggests another way to think about refinancing.
“If your goal is to save on monthly payments,” he says, “I would suggest refinancing if it will lower your interest rate by 1 percent or more.”
Let’s say you decide to refinance a $200,000 loan balance. Your current mortgage rate is 3.75% and your new rate is 2.75% — so this would lower your rate by 1 percentage point.
Here’s how the math works out:
- Loan balance: $200,000
- Current mortgage rate: 3.75%
- Current monthly payment: $1,200
- New mortgage rate: 2.75%
- New monthly payment*: $845
- Monthly savings: $355
*Refinance savings calculated using The Mortgage Reports refinance calculator. Your own rate and savings will vary
Assuming your closing costs totaled $6,000 (3% of the loan amount), your new loan would break even in about a year and a half.
So if you planned to stay in the home for at least two years or more, this refinance would probably be worth it.
However, the 1% rule doesn’t apply to everyone. Someone with a very low loan balance, say $100,000, might not refinance since dollars saved won’t be that high. And someone with an $800,000 loan balance might want to refinance for just a 0.25% reduction.
Should you choose a no-closing-cost refinance?
If you don’t have the upfront cash to refinance but you can score a much lower rate, you might consider rolling closing costs into your loan balance to avoid the out-of-pocket expense.
That means you won’t pay upfront, but you will pay interest on your closing costs — which end up costing you a lot more in the long run.
Another option is a ‘no-closing-cost refinance.’
No-closing-cost refinancing means your lender covers part or all of your closing costs. In return, you pay a higher-than-market interest rate. This ‘higher interest rate is probably much lower than your current rate, though.
Taking the higher rate costs you more in the long run than paying closing costs yourself. But you get a ‘no-risk’ refinance — meaning even if you sell or refinance again in 3 months, nothing is lost.
However, if you spend $4,000 buying down your rate, then you have to sell your home in 6-12 months, that money is gone forever.
For this reason, many people opt for a slightly higher rate and are free to refinance every 3 months if rates keep dropping.
Others want the lowest rate humanly possible.
“You have to look at what you are saving monthly versus over the long term,” suggests DiBugnara.
“If you need a short-term loan because you are moving soon, it may make sense to pay more in interest and not add to your loan balance,” he says.
“But if you will remain in your home for a longer period of time, it almost always makes more sense to take the lower interest rate and either roll the closing costs into the loan balance or pay these closing costs upfront at closing.”
So should you pay upfront or finance the closing costs?
Because borrowing is extremely cheap right now, “I almost always encourage my clients to roll the closing costs into the balance,” says David Dye, founder and CEO of GoldView Realty.
“I would much rather my clients keep their cash as reserves, in case rough times hit, than spend it paying down closing costs. The security of having an extra month or two of reserves is often much better.”
How your refinance rate is determined
The amount you can save by refinancing your mortgage will hinge on several factors, including your new interest rate, your credit score, and your loan-to-value ratio (LTV).
“Interest rates are unique to each borrower’s situation. They are determined mainly by two factors: credit score and loan-to-value,” says Dye.
A higher credit score typically earns you a lower mortgage rate. That’s especially true if you use a conventional loan.
As for LTV, the lower yours is — meaning, the more home equity you have — the lower your new loan’s interest rate is likely to be.
The amount you can save by refinancing depends on several factors, including your new interest rate, your credit score, and your loan-to-value ratio (LTV).
Your potential savings also depend on whether you currently pay private mortgage insurance (PMI) or FHA mortgage insurance premium.
If you have at least 20% equity when you refinance, you might be able to eliminate PMI or MIP and increase your savings.
“If the value of your home has gone up so that you have at least 20 percent equity based on the appraised value and the current balance on your mortgage, you may be able to drop PMI payments when you refinance, which can trigger even more in monthly savings,” Wright says.
Other good reasons to refinance: It’s not always about the savings
A refi may be worth it even if you don’t pocket an extra $100 per month or more.
“Some people who have significant equity built up in their home can use a refi to get cash out,” says Wright.
“Many seek a cash-out refi not necessarily to save money but to fund a costly home improvement project, pay for tuition, make an investment, finance a wedding, or pay down other debts, such as high-interest credit card debt.”
Refinancing might be worth it if you can take cash out, shorten your loan term, or switch from an ARM to an FRM — even if your monthly payment doesn’t go down.
Alternatively, you can refinance to shorten your loan term and save thousands in interest in the long run.
“For instance, let’s say you have 25 years left on your 30-year mortgage. [It] has a $300,000 balance, 3.5 percent interest rate, and a monthly payment of $1,347,” DiBugnara says.
“You refinance into a 15-year mortgage at 2.5 percent. Your new monthly payment will be $2,000. But it will only cost you $360,066 total to pay off your loan instead of $450,561 if you didn’t refinance.
“That’s a savings of almost $90,000. Plus, you’ve shaved 10 years off of the length of the loan,” he explains.
If you currently have an adjustable-rate mortgage, refinancing to a fixed-rate loan can provide peace of mind in the form of consistent monthly payment amounts that will no longer fluctuate from month to month.
How to decide if a mortgage refinance is worth it for you
Ultimately, the decision to refinance or not is up to you. To help you make a more informed choice, it pays to determine:
- How much lower your new interest rate will be
- How much you will save each month
- How much you will save over the life of your new loan
- How long you plan to remain in your home
- Future life goals and financial needs
“In most cases, refinancing with a significantly lower interest rate gives you more positive options. It creates a stronger position that allows you to better achieve your goals, whether they are to get cash out of your home, lower your monthly payment, or pay it off faster,” adds Wright.
Dye says the two most common objections to refinancing are the costs involved and the idea that your loan starts over.
“But don’t forget that, if you lack the upfront money for closing costs, you may be able to roll these expenses into your loan,” he says.
“And some lenders will allow you to keep your loan at the same term. For instance, if you have 24 years left, your lender may agree to start your new loan with 24 years remaining.”
Remember, you don’t have to refinance with your current mortgage lender.
If you can find a lender offering lower rates, better loan terms, or ideally both, you’re free to refinance with a different company.
That’s why it always pays to shop around and find your best offer when you refinance.