When to Refinance

By Leonard Baron MBA, CPA, San Diego State University Lecturer | June 9, 2011

So you’ve read that interest rates are some of the lowest on record, and you want to figure out if it’s time to refinance. 

And if not now – when to refinance? Now, financing has become significantly harder to do, and more expensive in the past few years, thanks to the financial crisis. But for those with good credit, financing is still possible, and may make financial sense.

In this article, we will run through some of the basic issues you should contemplate to help give you a framework for deciding whether to refinance. 

Regardless, the best person to help you sort through this framework and help you reach a final decision about when to refinance is your mortgage lending professional.

Questions to Ask Before Deciding When to Refinance

Planning on Moving?
The first question to ask is whether you’re going to own the house in question for at least two to four more years—the longer the better.  If you’re not planning on owning for at least this timeframe, refinancing is most likely too expensive and too much work to be a net benefit to you. HOWEVER: The bigger the mortgage, and the bigger the differential between your current mortgage interest rate and the rate you might get by refinancing – the more it might make sense, even on a shorter term basis.

Can you Even Get Refinanced?
It can be tough to get refinanced these days. If your loan-to-home-value ratio is too high, meaning that your property doesn’t appraise at a high enough value in comparison to the amount that is still outstanding on your loan, you may have trouble getting refinanced.  The bank may also consider you to be too high a risk if you’re self-employed or if you have credit issues. But the only way to know for sure is to check with your mortgage lender.

What are the Costs vs. Reduction in Interest Rate?
If you are qualified for financing, your lender will also let you know what interest rate you can secure, and how much it will cost you to refinance. So in order to make sense of it, you would need to do a quick rate vs. loan fees analysis. For example if you refinance a $300,000 loan it might cost $6,500 total once you add up points, escrow, title, appraisal, etc. If your loan is dropping by one-half of a percentage point you will save $1,500 per year – which is about $1,000 after taxes. So you are paying $6,500 to save $1,000 per year, it will take you 6.5 years to earn your money back. That isn’t a very good deal. If the numbers are $6,500 in loan fees to save $3,000 per year in interest, that’s a 2.2 year payback period – and a much better deal!  You can use the “Should I refinance my home mortgage” calculator on our Power Tools and Resources page (under the Home and Mortgage section).

Which Rate/Point Combination to Pick?
Ok, so everything looks good and you decide now is when to refinance.  Great. The lender gives you a few rate/point options. So do you want 5.0% interest rate at one loan origination point? Or 5.25% at one quarter of one loan origination point? If you compare the amount that it costs you, to the amount it saves you each year, you can figure out your payback period just like in the above paragraph, when you figured out if it made sense to refinance. Take one-third off the annual interest savings to account for the tax deduction you get for interest. This is a little complicated, but if you understand the prior paragraph, you should understand this one.  Or, you can just plug the competing scenarios into our “Should I refinance my home mortgage calculator!”

Compare Two Bids.
Lastly, you should use your trusted mortgage lending professional to do the loan.  However, you might also consider getting qualified by at least one other lender, and then compare their costs and rates against each other. That way you can be sure your preferred lender is giving you a fair rate/point combination on your refinance.

Generally speaking, it can be time consuming and challenging to properly dissect the costs vs. benefits of refinancing a property. That’s why it can be helpful to turn to trusted lending professional who you know well and who you trust to give you a fair deal.

The above guidelines should provide a reasonable framework to help you determine when to refinance. Again, the rule of thumb to remember is: the bigger the loan and the bigger the rate drop, the more worthwhile it typically is to refinance.
 
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Author Leonard P. Baron, MBA, CPA, is a real estate lecturer at San Diego State University, a long term residential real estate investor and author of Real Estate Ownership, Investment and Due Diligence 101 - A Smarter Way to Buy Real Estate.

You can learn more about him and get his free – “Real Estate Buying Due Diligence Checklist” at professorbaron.com - under Chapter 1 – Due Diligence (no sign up or registration needed just download it!)

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