When does it make sense to refinance your home?

When does it make sense to refinance your home?

There are a number of situations in which refinancing a home mortgage may make sense. For example, you may have purchased the home at a time when interest rates were much higher and you now want to take advantage of lower rates that exist today.  In addition, homeowners may want to lock in a fixed rate on their mortgage if they currently have a variable rate loan and they believe that rates will rise.  Or, a homeowner may just want to shorten the term of his or her loan.


Is it worth the trouble?

Refinancing can seem very beneficial, but a borrower must weigh the advantages with the costs to make sure it really is the right thing to do: the potential savings must be worth the costs of doing it.

The rule of thumb has been that you should refinance if the new rate will be at least 2 percentage points lower than the current rate. But other factors could change that – it may be worth it even with a small rate difference if certain other factors are present, but more of a break might be required in other scenarios.


Other factors

There are a number of other factors that need to be considered in the “cost benefit analysis” of refinancing.

  1. Closing costs. Possible prepayment penalties on the old loan, points and fees on the new loan, and recording and attorneys’ fees, can amount to 3 or 4% and are generally due at closing of the new loan. The borrower must consider the loss of earning power on these funds.
  2. Projected length of ownership. If the closing costs are financed they can be spread over the length of the new loan; therefore the longer the projected period of ownership, the smaller the spread of between the old rate and the new rate needs to be.
  3. Income tax bracket. The borrowers’ tax bracket, and therefore the value of the interest deduction, needs to be considered.
  4. Deductibility of the interest. Mortgage interest on $1,000,000 of acquisition debt on a first or second residence, and $100,000 in home equity debt, is generally deductible. And depending on the borrower’s income some of this interest deduction may be phased out. Acquisition debt refers to debt that is incurred to purchase, construct or substantially improve a qualified residence and is secured by the home. Home equity debt is debt that is not necessarily acquisition debt (could be debt used for other purposes) but is secured by the home.


How many months will it take to break even? Here’s how to do the math

The real cost to refinancing is the closing costs. To determine how many months it will take to make up these costs with the savings from the new loan, perform this calculation:

Old payment amount –  new lower payment  =  monthly savings


Closing costs /  monthly savings  =  number of months to break even

Refinancing an old home loan could mean lower monthly payments and maybe changing to a fixed rate instead of a variable rate. If projected time in the house is short, any savings in payments could be consumed by the costs incurred.  Also, if one plans to sell in a short amount of time a borrower may want to consider an adjustable rate mortgage (ARM) that starts out with a low rate – with plans that the house is sold and the loan is paid off before the rate can climb.

Also, consider paying off consumer debt before paying off a home loan since the consumer debt is not deductible and therefore costs more.


If it makes sense for you, please contact us at watrust.com or 1.800.788.4578 to find out how we can assist you on your mortgage financing needs.

About The Author

As Vice President and Senior Wealth Advisor, Greg provides financial analysis to high net worth individuals. He is the author of several articles for various publications and nonprofit organizations on estate and financial planning subjects.