When Is The Right Time To Refinance Your Mortgage? [Guide]

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With mortgage rates at an incredible low, it makes sense to want to refinance your mortgage. While this idea sounds tempting, especially when it can mean a lower monthly payment and a lower interest rate, it’s important not to rush into this decision.

If you are not careful, you can place yourself into a sticky financial situation.

A refinancing mortgage loan is designed to replace your current home loan. These loans also help you to tap into your home equity to get a better rate. However, it is not always the right time for everyone to refinance their mortgage.

You need to consider several factors before refinancing your home from your current mortgage to a new mortgage. These include how long you plan to live in your current home, your credit score, financial goals and your risk/payoff factor.

It is important to take all of these factors into consideration before refinancing your home. When is the right time to refinance your mortgage depends on your individual situation.

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How Long are You Planning on Living In Your Home?

One of the first things to consider before looking at refinancing your home is how much longer you plan on staying in your current home. If you are planning on living in the home for at least ten or more years, you will build equity to help you when you are ready to move. Refinancing may require you to use some of that equity that you can continue to build without refinancing.

On the other hand, if you plan on moving within a few years or months, refinancing would not be sound advice. Unless your home is close to being paid off and you can pay off the refinanced amount before you plan to move, you will be taking on unnecessary debt.

Something that can help you to decide on this is what is called the break-even point.

This refers to the time that it will take you to financially recoup closing costs from your refinance. Look at the time it will take you to recoup that loss versus your savings ($3,000 closing costs, $100/month savings= 30 months). Then look at how your current home will fit your lifestyle. If you can see yourself staying in that home for that time period, then go ahead on refinancing; if not, it may not be a good choice.

Another factor in refinancing is that you will likely extend your loan term. If your original loan is a 30-year mortgage, you may end up spending more in the long-run by refinancing. This is due to the addition of interest costs, as many loans are frontloaded with fees. You can check with your mortgage lender for a loan for the remainder of the term of your original loan; they may end up being able to save you money and lower your payments.

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What is Your Credit Score?

One of the most important things to keep in mind when thinking about refinancing your mortgage is your credit score. Any time you see to receive any type of loan, the first thing the lender is going to look at is your credit score.

The better your score, the better your rate is the general rule of thumb.

If you are not taking too many lines of credit or other debt and can make payments on time, the more likely you are to receive a reasonable rate. If you have a low or poor credit score, it’s probably a good idea to work on improving your credit before refinancing.

Credit scores are important when looking at conventional loans. However, FHA loans will accept lower scores, but don’t look favorably at scores under 500 points. Having a low credit score can also require you to purchase private mortgage insurance.

So what if your credit score is low? Luckily there are things you can do that will help your credit score to refinance your mortgage in the future. Make sure you pay your bills on time. If you have a credit card, keep spending below 30% of your credit limit. Keep an eye on any errors on your credit report and do not make too many credit inquiries in 30-days.

Your ideal credit score should be around 700 points. If your credit score is at or close to this score, you will have a better chance of a good rate.

On the other hand, if you do not have a high credit score, you can still get a good rate with a low DTI (debt-to-income rate). This score looks at how much your monthly debt is in relation to your gross monthly income. A ration of less than 43% can aid in a lower interest rate if your credit score isn’t high.

Related: What is Your Long-term Debt Ratio and What Does it Mean?

What are Your Overall Savings?

The rates for mortgage refinancing are continually shifting.

That’s important to keep in mind, as what you get quoted may be slightly higher or lower than what you initially saw. While some will see a less-than one-percent change and not think it is worth it, for some, that can mean significant savings. Many advisors will say anything less than a 2% discount is not worth refinancing, but that line of thinking has changed in recent years.

One of the best ways to determine your savings is by using a refinance calculator. This helpful tool can help you to weigh the costs and benefits of refinancing.  Having a lower interest rate allows for lower monthly mortgage payments and the ability to gain equity in your home. However, there are other financial considerations to keep in mind.

While in many cases, refinancing can save you a lot of money, it can also cost you more money than the savings are worth. You should factor in how much equity you have in your home currently (20% is ideal).  There are also costs included in refinancing such as appraisals, credit checks, origination fees and closing costs. You also need to see if you will have a penalty for paying off your loan early.

The ultimate factor to see if you will save any money by refinancing is calculating your monthly payments once you have a new quote on an interest rate.

You can then weigh if the savings will be worth the effort of refinancing. Working closely with a mortgage professional can aid you in this process and will help you determine if refinancing is financially worth your time.

What Are Your Financial Goals?

Knowing your financial goals is an important consideration when looking at refinancing your mortgage. What will you do with the extra money you will possibly save. Having clear goals for what to do with the extra money will keep you from possibly spending money on things needlessly.

Refinancing can allow you to pay your home off quicker. With a lower interest rate and monthly mortgage payment, you may be able to take your savings and pay off the principal of that debt.

Some borrowers will use their savings to take care of other debts. Using your refinanced mortgage as a consolidation loan to help them in paying off other debts. Taking out a “cash-out refinance” can be a way to aid in paying off other financial needs, such as paying off credit cards or home renovations. The borrower takes out more than they owe as a way to take care of these other debts. A refinance loan can be an option for those trying to resolve previous financial difficulties and looking for a potentially lower rate.

While this can be useful in putting all of your debts on one payment, there is a level of caution that should be practiced. You want to make sure you will not be tempted to be putting yourself back into financial issues. If you have difficulty in managing credit cards, etc. and do not change those spending habits, you may find yourself back in trouble once some of those bills are paid off.

If you need to reach out to a financial advisor if this is a goal. They can help you to find ways to manage your money and your debts wisely.

Perhaps your goal is to save up money for other purchases. Or, you may be wanting to build up your financial emergency fund. This is a few thousand dollars placed in your savings for any of life’s emergencies. Freeing up a few extra hundred dollars a month with a refinance can greatly aid building these funds. If you find yourself in a monetary emergency, look at all your options before refinancing your home, as you may have more of a financial burden for a short-term emergency.

Another possibility is that you want to move within the next few years. With a short-term adjustable-rate loan, you can take the savings and save up for a down payment for your next home. You may have the goal of moving within five years, and taking a shorter-term loan can allow you to pay more on your remaining mortgage and save some money to put aside.

Knowing what you are going to do with the money you stand to save with a refinancing loan is an important consideration. Having a clear goal of “I want to put X-amount of money aside for X” will help you to decide if it is a good choice to refinance your loan.

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Convert Loan from Adjustable-rate Mortgage to Fixed-rate Mortgage?

Refinancing can also allow you to adjust the terms of your loan.

Adjustable-rate loans can be good for short term loans, as they gradually increase over time, ideally along with your income. Most of these rates are low at around a 3% increase over a short period of time. However, once these terms reset, your rate may increase. While these loans may have a huge amount of savings in the beginning, overtime rates may increase when you are paying more than a fixed-rate mortgage.

When that time comes, it may be worth looking at refinancing for a fixed-rate mortgage. A fixed-rate mortgage will be longer-term, usually 15 or 30-year loans. These loans are beneficial, as the rates do not fluctuate. This can be beneficial in the long term where you do not have to worry about increased interest rates in the future.

On the other hand, if you are planning on leaving your current home in the short-term, switching from a fixed-rate to a shorter-term adjustable-rate loan can be beneficial. They can have a reduced mortgage interest rate and payments without worrying about increasing interest on a longer-term loan.

Related: The Definitive Guide to Mortgage Refinancing

When Not to Refinance

One final note is to know when it is not a good time to refinance. If you are planning on selling your home soon or have a few years left on your current loan, it is not a good time to refinance. If your credit or finances need work, focus on handling those debts before looking at taking on another loan. Also, look if your loan has a prepayment penalty. These penalties are in place if you try to pay off your loan too early.

Look at your Closing Disclosure or talk to your lender to see if your loan has one of these penalties before taking out a new loan.

While the time seems right for many to refinance their mortgage, it is important to weigh your options. You should examine what you hope to gain and any risk factors involved.

While often refinancing is a great idea, it is important to know if this move aligns with your personal goals. With many people looking to refinance their mortgages, most refinancing loans can be closed within 30 days. One of the best things to do is to contact your mortgage company and discuss the options with them. They will often help you to decide if refinancing is right for you.

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