Submitted by Fox First at Ten on December 20th
The way mortgage rates have been falling the past three years, a lot of homeowners are not only refinancing their mortgages, they're doing it for a second or even a third time, maybe more. Should you join them?
Many homeowners are leery of refinancing again because they're heard it's not a good idea to refinance too often. And that's true -- continually refinancing in pursuit of ever-lower mortgage rates can be a recipe for financial disaster, piling up origination fees faster than you can pay down your mortgage by refinancing.
The key though, isn't how often you refinance but how much you save by refinancing. If you can whack a full percentage point off your current interest rate, it's probably going to make sense to refinance again, even if you previously refinanced just last week. At the same time, if you're only going to shave off a quarter of a percent, refinancing is going to be hard to justify, even if you've had the same loan for 10 years.
The problem with frequent refinancing
Here's the problem with refinancing too often. Every time you take out a mortgage, either to buy a home or refinance your current loan, you pay origination fees. These typically run from 3 percent to 6 percent of the loan amount. You can pay for those up front, but many people simply choose to have them added onto the loan.
This makes it pretty clear why it's not a good idea to refinance too often. If you have a $200,000 mortgage and refinance every six months, that's $6,000-$12,000 in fees you're tacking on twice a year. With a 30-year mortgage, you'd be piling on new debt faster than you can pay it down with your regular payments.
So how often should you refinance?
The main thing about refinancing is that it should save you more than you pay in fees to refinance. Obviously, you're not going to realize those savings immediately, but over time as your savings from a lower interest rate add up.
If refinancing costs you $6,000 in origination fees but saves you $100 a month on your mortgage payments, it's going to take you 60 months, or five years, to reach your "break-even" point where your savings exceed what it cost you to refinance in the first place. If it saves you $150 a month, you'll reach your break-even point in only 40 months, or less than 3 ½ years.
This doesn't mean you have to reach your break-even point before it makes sense to refinance again. Any savings from your new refinance are on top of what you saved from your last one. So if your first refinance saved you $150 a month, and you can save another $100 by refinancing again, you'll be saving $250 a month over what you were paying on your original mortgage.
So generally speaking, you should only refinance as often as you can save enough to make it worthwhile.
About break-even points
The important thing is that you should be able to reach your break-even point in a reasonable time. Five years or less is pretty reasonable -- you'll be saving enough that you'll "pay off" your origination fees quickly enough to make it worth your while.
If you're looking at eight to 10 years to reach a break-even point though, you really ought to consider whether you'll be saving enough to make it worthwhile. Many people don't even stay in the same home that long, meaning you might move out before you even reach your break-even point. And if you move just a few years after that, how much have you really saved?
Generally, if it's going to take you a decade to reach your break-even point, you're probably not saving enough to make refinancing worthwhile, even if you expect to be in the home longer than that. You may find there are other ways that provide a better long-term return on your money than refinancing to obtain such a small savings.
How much will you save?
The general rule of thumb is that you shouldn't refinance unless you can save a full percentage point -- for example, reducing your rate from 5 percent to 4 percent. However, that's not hard and fast. How much you're going to end up saving depends on other factors as well, including the size of your mortgage, how long you've been paying on it and the length of the term of the new mortgage you'll be taking out.
The only way to really know how much you'll save is by using an online mortgage calculator, such as one in the links on this page. This lets you enter your loan amount, interest rate and length of the loan to determine exactly what your new mortgage payment will be.
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