The question can be a balancing act of fees and costs of refinancing versus the savings achieved through a change in interest rate on your debt. It can be a matter of readjusting the length of your mortgage to reflect major changes in household income.
In the case of a decline in market interest rates, refinancing can save you tens of thousands of dollars by bringing down the overall cost of borrowing. Similarly, if you have an adjustable rate mortgage (ARM) refinancing and obtaining a fixed-rate mortgage can eliminate the uncertainty of ever-changing market interest rates. Refinancing can be a great advantage for borrowers who had poor credit history when they took out their mortgage and qualified only for a subprime loan. Subprime loans are offered to borrowers who are considered a lending risk due to bad credit and carry a much higher interest rate. If a subprime borrower has stayed current on payments, the increased credit score could qualify for a lower interest rate.
Refinancing also enables borrowers to readjust the length of a mortgage according to their ability to pay. If a couple with a 30 year mortgage can afford to repay the debt sooner than anticipated, they may reduce the payment period to 15 years to reduce the long-term cost of borrowing. For those who signed on for 15 year mortgages and now find the payments unmanageable, refinancing to a 30 year mortgage lowers month payments and can allow the borrower to remain in his or her home rather than facing potential foreclosure.
One of the major costs of refinancing is closing costs. Two to three percent of the total loan amount is typical, but it may be as high as five percent for those with poor credit. Closing costs and the length of time that you plan to stay in your house determine whether refinancing will be worthwhile for you. The savings of a lower interest rate may not recoup the costs of refinancing until after a year or two of lower payments. If you plan to sell the house within that time period, refinancing is probably not worth the cost. However, if you do intend to stay in the house for the long term, the savings of a lower interest rate continues to accumulate over the life of the loan.
Considering refinancing will require some math and logical reasoning, but it doesn’t have to be rocket science. A general rule of thumb is to consider refinancing if the interest rate on your mortgage is at least one percent higher than the prevailing market rate. Your specific numbers vary based on factors like the length of your mortgage, what you can afford to pay each month and how long you intend to stay in your house. MSN Money has a useful refinancing calculator that can help you answer the question: to refinance or not to refinance?