Even though we as a company counsel our clients never to take interest rates into consideration when obtaining a mortgage, we understand it is a hot button issue, as well as potentially cost saving. That said, your mortgage is a financial plan, not an interest rate. To that end, let’s dive into the “math” of when it makes sense to refinance in regards to rate:
Homeowners who can lower their mortgage rate by 1 percent or more are generally in a great position to refinance.
But what if you can only lower your rate by 0.5 percent — or even 0.25 percent?
The answer might be yes, especially if you can get the lender to cover your closing costs and still generate savings.
The “right” amount to lower your mortgage rate is not set in stone. It depends on your refinance goals and how much you want to pay upfront to get your rate as low as possible.
Is it worth refinancing for 1 percent?
Refinancing for a 1 percent lower rate is often worth it. One percent is a significant rate drop and will generate meaningful monthly savings in most cases.
For example, dropping your rate 1 percent — from 3.75% to 2.75% — could save you $250 per month on a $250,000 loan. That’s nearly a 20% reduction in your monthly mortgage payment.
Those monthly savings can be put toward daily living expenses, emergency funds, investments, or paid back into your mortgage to pay the loan off early and save you even more in interest.
Refinancing for a 1 percent lower rate:
Keep in mind, “breaking even” with your closing costs isn’t the only way to determine if a refinance is worth it.
A homeowner who plans to move or refinance again before the break-even point might opt for a no-closing-cost refinance.
A no-closing-cost refi typically means the lender covers part or all of your closing costs, and you pay a slightly higher interest rate.
Accepting a higher rate will eat into your monthly savings. But if you can avoid closing costs and still save month-to-month, there’s no break-even point to worry about.
It’s often a win-win situation for borrowers who only plan to keep their new loan a few years.
Another option could be rolling the closing costs into your new loan.
This will increase your principal balance and total interest paid. But if you’re going to keep the loan for more than a few years, rolling closing costs into the loan amount may be more affordable than accepting a no-closing-cost loan with a higher interest rate.
Is it worth refinancing for 0.5 percent?
There are two common scenarios where refinancing for 0.5 percent could be worth it:
- If you’ll keep the new loan long enough to recoup closing costs
- OR, if you can get the lender to cover your closing costs
First, let’s look at a break-even scenario:
Remember, the less your rate drops, the less you save each month. So it takes longer to recoup your closing costs and start seeing “real” benefits.
For example, dropping your rate 0.5 percent — from 3.75% to 3.25% — could save you about $150 per month on a $300,000 home loan.
That’s a decent monthly savings, but it will likely take you over 3 years to break-even with closing costs. So you want to be sure you’ll keep the refinanced loan for at least that long.
Refinancing for 0.5 percent — break-even method:
When is it worth it to refinance?
How much lower you can get your interest rate isn’t the only thing you should consider before refinancing.
The overall benefits, of course, can be huge.
A lower interest rate means you’ll have smaller monthly mortgage payments. And it often means you’ll save thousands (maybe tens of thousands) by the time your loan is paid off.
But you have to weigh those savings against the inherent downsides of refinancing:
- You have to pay closing costs, which are typically 2-5% of the new loan amount
- You restart your loan term from the beginning, usually for another 30 or 15 years
- If your new interest rate isn’t low enough, you might actually pay more interest in the long run because you pay it for a longer time
Plus, most people don’t actually stay in their homes long enough to pay their mortgages off.
So, you should make sure the savings you calculate are realistic, and based on the amount of time you plan to keep your mortgage.
This is all to say that the numbers in this article are only examples — use them as guidance, but of course make sure your refinance decision is based on your own loan details and financial goals.