Hello to the readers of the First Team Real Estate Blog. My name is Shanne Sleder and I am a Mortgage Banker from San Diego, California and the author of SanDiegoMortgageNews.net.
As a mortgage banker who works with all types of mortgages, I am often asked, “Does it make sense for me to refinance my home loan?” or “How much does my interest rate need to decrease to make it worthwhile to refinance?”
While these questions really depend on each individual’s home loan and their circumstances, I would like to discuss my viewpoints after 12 years of experience and how some past standards no longer hold true.
How Much Does My Rate Need to Decrease?
There was an old standard that was used in the mortgage industry that homeowners who are looking to refinance often repeat to me. It states, that the homeowner needs to save at least 1% on their interest rate in order for a refinance to make sense.
While this may have been the case years ago when the average mortgage was $100,000 -$150,000, it is no longer the case now that mortgages are closer to $300,000 or higher in many parts of the country.
Here is an example:
If a homeowner’s loan is $150,000 and they are able to save a half percent on their interest rate by refinancing, they would only save about $44 per month. In most situations this refinance would not make financial sense.
Instead, if the homeowner has a $400,000 loan and can decrease their interest rate from 4.5% to 4.0% on a 30 year fixed loan, that would save them $117 per month or $1,404 per year. This example demonstrates that it can make sense to refinance your mortgage if you can lower your interest rate by as little as a half percent. Even the slightest changes in interest rates can have a big impact on how much you pay.
Do I Save Enough on my Refinance to Make the Closing Costs Worthwhile?
When you refinance your mortgage there is another factor you must take into account. How much are you going to have to pay in closing costs to refinance your mortgage?
A good rule of thumb I use in my practice is that the homeowner should be able to recover the cost of the refinance with the monthly savings obtained within the first 3 – 4 years.
In the example above, I use estimated closing costs of approximately $3,000 for a $400,000 refinance. Because the yearly savings from the refinance is $1,404 it would only take 2.14 years to recover the cost of the refinance.
You can see from this example a refinance that saves only a half percent still can make perfect sense even with paying closing costs if your current loan is large enough.
No Cost Refinances
Another option that is available to people looking to refinance is a no closing cost loan. In a scenario like this, the mortgage broker pays all the closing costs of the refinance for the client. There is a trade off. Usually, the interest rate will be about .25% – .375% higher than if the client were to pay their own closing costs. There are many times where this makes more sense for the client and their financial plan than paying the full closing costs.
For example, if a client just completed a refinance in the last few years and paid the full closing costs, it may not make sense for them to pay the costs again in order to save a half percent in rate.
On the other hand, if the lender is able to cover all the closing costs and still save them a half percent in rate, then it becomes a very easy decision for the client to move forward with the refinance. The client is not saving quite as much as they could if they paid the full costs and received the lower rate, but they are still saving a significant amount without having to pay any closing costs.
