When Should I Refinance?

A friend asked me the other day, “When should I refinance?” That is a question that I hear quite frequently and as a lender it really is not a simple answer. The best answer that I can give is know your lender and talk thoroughly about your situation.

There are several questions to ask yourself; the first one being “How long do I/we plan to be in this house?” If you intend to move, and sell your home, in 2-3 years then refinancing is not a good idea. If you intend to move, but want to keep this property as an investment and convert it to a rental property then you should still consider refinancing.

The second question is does it make sense financially? Many people tell me that it doesn’t make sense to refinance because they can’t lower their rate by 2%. You aren’t looking at how much you drop your rate, but how quickly you can recover the investment. About two years is the amount of time is should take to recover the cost of a refinance by what you save each month. If it takes longer than that, then ask yourself honestly, “How long will I be in my home?” If you intend to live there until you die, a refinance makes much more sense.

Are you currently paying mortgage insurance? Mortgage Insurance (PMI) occurs whenever you borrower more than 80% of the value of your home. If you bought a home for $200,000 and put $20,000 down, then you started with a 90% loan to value ratio. Once you pay down the principal balance to 78-80% of the original sales price (or appraised value whichever is lower) the Mortgage Insurance will automatically be removed from your payment. Let’s assume that your current balance is about $168,000 that would put you at an 84% loan to value. Even in today’s economy, it may be possible for you to get an appraisal on your home of $210,000. That would mean that if you refinanced and paid your closing costs, you could eliminate the PMI. Eliminating the PMI may make it worthwhile; even at the same rate. Appraisals are a huge part of the refinance transaction in today’s market. Most homes (at least in Knoxville) are worth more today than what someone paid for them 5 years ago. How much more depends on the neighborhood and the condition of the home.

What is the rate that makes sense for your situation? Available rates cover a wide range based on cost and credit score. For instance, Conventional 30 year rates are available today from 4.25% to 6%. Trust me, no one comes into my office and says, “I want the 6% rate.” The truth of the matter is that it costs money to borrow money and the lower your rate, the more you pay in fees. If it costs you .005% to drop your rate .125% it probably is not worth it unless you intend to stay in the property for over five years. On a $100,000 loan, dropping your rate from 4.75% to 4.625% saves you $7.50 per month. If it costs you half a point (.005%) to get the lower rate that is $500 in fees. If you divide $500 by $7.50 per month savings, it takes you over 5 years (66 months) to recover the cost of the lower rate. If you move in 5 years, you actually lost money.

When should I refinance is a personal question that deals with many options and decisions that you as an individual (or family) need to sit and discuss with your lender. Your lender should take the time to show you options and discuss whether or not it makes sense to you to refinance. My door is always open if I can help you work through your questions.


This blog is for informational purposes and is the opinion of the writer. In financial matters always solicit professional advice and legal counsel if necessary.