When Is The Best Time To Refinance Your Mortgage?

Have you refinanced your mortgage in the past year or so? If you haven’t refinanced yet, are you thinking about doing it? If so, you may want to get started now, and here’s why…

Rates Are At All-Time Lows

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Mortgage rates are currently at the lowest levels in recorded history. If you’re waiting for better rates, they may never get better than they are right now. It isn’t that they couldn’t go lower—they can. But the historic expected return on long-term fixed investments is 3 percent, plus an allowance for risk (default).

Since 30 year fixed rate mortgages are only a little above three percent now, the chance of it going any lower is remote. And if it did, it would only drop fractionally. At these levels, rates will no longer drop by full percentage points—they’re already too close to the ground.

When Should You RefinanceThe flip side of a rate move is that there’s plenty of room for mortgage rates to rise. At such low levels as now they may drop fractionally, but they can very easily move up in whole percentage points and maybe even a few of them.

Right now, a lot of people are sitting with 5-6% mortgage rates wondering if they should refinance now. With rates below 4% refinancing makes sense. But an upward move of just 1% would effectively close the refinance window and possibly for a long time.

Advantages Of Refinancing

Most often, when homeowners refinance their mortgages they do it to lower their payments. That’s a good enough reason by itself, after all, the less money you have to pay on your monthly mortgage payment, the more you have available for everything else.

But lower interest rates even by themselves may be a compelling reason to refinance, even if they don’t result in a radically lower monthly payment.

A lower interest rate means less of your monthly house payment is going toward interest, and that’s important because interest is a pure expense. A lower rate also means that more of the payment is going toward principal, and that’s equally important because principal builds home equity—and that’s an asset.

Take Advantage Of Low Rates To Pay Off Your Mortgage Sooner

One of the advantages that refinancing to a lower rate provides is an increased ability to pay off your mortgage faster. We just touched on how lower rates translate into more of your monthly payment going to principal reduction, but that’s just the start of what can be done.

If you can combine the lower rate with a shorter loan term, you can cut years off your mortgage. But a lower monthly payment can also enable you to make additional principal payments that will also shorten your loan term.

Let’s say that in refinancing you lower your monthly payment by $150 per month; if instead of settling comfortably into the new, lower payment you continue making the old payment amount. All of the additional $150 will go into principal reduction. That will take at least a few years off your mortgage.

How To Avoid The Biggest Refinance Mistake

If your plan is to payoff your mortgage faster as a result of the refinance, there’s one common trap that you want to avoid.

Many homeowners, anxious to lower their monthly house payment, recast the new loan back to the original term. If they have 25 years remaining on a 30 year mortgage, they refinance the new loan as a 30 year term as well. With that action, they’re back to square one on their mortgage—30 years to go.

They’ve effectively converted their mortgage into a 35 year loan—30 years for the new loan plus the five years they’ve already paid on the old one. That will have the exact opposite effect on paying off your mortgage faster.

If you do refinance, be sure that the term of your new mortgage does not exceed the remaining term of the current mortgage. If you started with a 30 year loan, and have 20 years remaining, your new mortgage should be 20 years, not 30.

Are you thinking of refinancing your mortgage? What’s keeping you from doing it now?

Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.

Last Edited: 24th August 2012

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    Share Your Thoughts:

  1. says

    We refinanced last year. The rates have dropped slightly since then but not enough to justify another re-fi. We were four years into a 30-year mortgage and re-financed into a 15-year, so the total term will be 19 years.

    • says

      Hi MB–You absolutely did it the right way–lower rate AND shorter term. As long as you can comfortably afford the payment, that’s a relatively pain free way to pay off your mortgage early.

  2. says

    We’re currently looking into refinancing again in hopes of reducing the rate since our last refinance was 3-4 years ago, and the rate is still above 5%. We’re hoping to drop that down to the 3.5% range or lower depending on what type of a mortgage we get into – a 20yr or 15 yr. We’ll see how it goes! Rates are ridiculously low!

  3. says

    Very good point of being careful about the term: making sure the ending date for the new mortgage is not further out than the original one!

    And also about keeping the monthly payment the same and using that to shave a few years off the term of the loan.

  4. says

    No equity is what is stopping us. We started the whole refinance process late last year but when the appraisal was nearly the exact amount we owed on the loan all progress stopped. And since are loan isn’t backed by freddie mac or fannie mae we can’t take advantage of any of the helpful programs that are out there. This drives me insane! but at least our mortgage is our only debt and the payments are very easy to pay

  5. says

    I just refinanced my primary house from 4.875% to 3.75%. That will save me about $90,000 over the life of the loan and it’s lowering our monthly payment by about $500. It’s a great time to refinance right now.

    • says

      The key phrase is “over the life of the loan”. If you move or refinance again the savings may not be realized.

      I believe most home owners refinance too frequently. Mortgage interest is amortized so that most of your early payments go to interest. Refinancing returns you to the top of the amortization schedule.

      Most don’t stay in one place long enough to make it all work.

  6. says

    Now is great time to refinance. Like the point of put the saving to pay down principal. You also pointed out one downside of refinancing if you extend your mortgage. Rate is important but some other things to consider before refinancing is
    How long to you plan to live in the house?
    What are the closing cost to refinance? You want to make sure you recoup those cost quickly.
    Will you have enough equity in the house? You don’t want to have to pay down a significant amount of principal just to refinance.
    Make sure your credit looks okay. Mortgage underwriting is not as easy as it was 5 years ago.

    Nice post

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