Insights

When mortgage rates start to drop, how do you know if you can benefit from refinancing your current mortgage? The answer, not surprisingly, depends on several factors, most notably your financial health, your current mortgage interest rate and how long you plan to stay in your home. Here are some things to consider:

Your finances

Before deciding to refinance, take an honest look at your current financial health. Have you been paying your bills on time every month, or have you been late or missed several payments? Do you have tiny credit card balances or have you run up mountains of credit card debt?

Your ability to qualify for low mortgage interest rates depends heavily on your three-digit credit score. That score will not be strong if you have a recent history dotted with missed car loan payments and soaring credit card balances.

To qualify for today's lowest rates, you'll need a credit score of 740 or higher on the commonly used FICO credit-scoring system. If your credit score is much lower than that, you might not qualify for an interest rate low enough to make refinancing worth your while.

Your current interest rate

Interest rates, of course, play a key role in whether you can justify refinancing your mortgage. If you can significantly reduce the interest rate on your mortgage, you can realize dramatic savings by refinancing.

For instance, if you originally obtained a $200,000 mortgage at a 6 percent rate and made your $1,199.10 payment each month for 60 months, you would have an outstanding balance of $186,108.71. If you refinance that outstanding balance at an interest rate of 4 percent, your monthly mortgage payment will fall to $888.51 a month. That is a savings of $310.59 a month or $3,727.08 a year. That is significant.

However, if your original $200,000 mortgage had an interest rate of 5 percent and 60 months later you lowered it only to 4.5 percent by refinancing, you'll only save about $143.07 a month. That might not be worth the time and money of refinancing.

Remember, refinancing your mortgage costs a significant amount of money. According to estimates from the Federal Reserve Board, you can expect to pay from 3 to 6 percent of your outstanding loan balance in closing and settlement costs when you refinance. For a $200,000 mortgage balance, that comes out to $6,000 to $12,000. You want to make sure that you'll be saving enough money to pay back those fees over a reasonable period.

Length of stay

Finally, consider how long you plan on staying in your home before you decide to refinance. The goal of refinancing is to save money. You will not be able to do that if you plan on selling your home before you can realize the financial savings of a refinance.

For instance, if you saved $1,500 a year by refinancing with $5,000 in closing costs, you'll need to stay in your home for at least four years before your savings pay back those costs.

Does it make sense to refinance?

Our refinancing calculator can help you determine how long it will take for you to recover closing costs and break even.


This content is not intended to provide legal, tax, accounting, financial or investment advice or indicate the suitability of any product or service for your unique circumstances. You are encouraged to consult with a qualified legal, tax, accounting, financial or investment professional based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.
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