How to decide if you should refinance your mortgage

With the Federal Reserve rate at almost zero, it has never been cheaper for Americans to borrow money.

For current homeowners, now is a good time to refinance your mortgage, especially as a way to keep more money in your bank account amid the uncertainty of the COVID-19 pandemic. But just because mortgage rates are low doesn’t mean refinancing is the right move for all.

4 ways to determine if it's time to refinance

Below are four quick ways to determine if you should refinance your mortgage loans now.

1. You have a good credit score and debt-to-income ratio
2. You've compared mortgage rates and mortgage lenders
3. You've crunched the numbers
4. You're planning to stay put

1. You have a good credit score and debt-to-income ratio

​The higher the score and the lower the debt-to-income (DTI) ratio, the more likely a borrower is to get the best loan term and mortgage rates.

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In order to do the math on what you could potentially save, you’ll need to know these numbers first before actually shopping. Do you know your credit score? Can you calculate your DTI?

How to check your credit score and debt-to-income ratio

Your credit score is easy enough to find using one of many online free credit score websites and it is easy to find a rough measure of your debt-to-income ratio.

1. First, take your monthly pre-tax take-home income
2. Then, add up all debt payments (mortgage, car payments, student loans, credit cards)
3. Then, divide your debt by the gross monthly income to get a percentage

According to the credit bureau Experian, lenders typically like to see a credit score of 620 or above on a mortgage refinance. When it comes to the debt-to-income ratio on any type of mortgage loan, most lenders prefer borrowers to have less than 40% DTI.

2. You've compared mortgage rates and mortgage lenders

The only way to know if you’ll receive a rate lower than the one you have now is to shop interest rates with multiple lenders. By rate shopping, you can casually see what rates you may qualify for currently and if lenders are offering any incentives like low closing costs for refinancing.

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3. You've crunched the numbers

Dust off your math hat; the best way to determine if refinancing puts cash back in your pocket is to utilize all the free online tools available to you.

Using a refinance calculator with your own numbers -- loan balance, interest rates, closing costs -- allows you to see how much you can save, how long it will take to pay off closing costs, and how much interest you’ll now pay over the life of the loan. With powerful calculations in your hand, you can decide if now is the best time to refinance in addition to finding out how much refinancing can lower your monthly payment.

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4. You're planning to stay put

Many homeowners are surprised with the fees that come with refinancing a mortgage.

After all, you’re taking out a completely new loan, so the closing costs are much the same as they were when you first purchased the home. Fortunately, homeowners can roll these costs into the newly refinanced loan, but these costs could offset the benefits of a refinance, at least in the short-term.

THE BEST (AND WORST) REASONS TO REFINANCE YOUR MORTGAGE

In order for refinancing to make sense, you have to be willing to commit to staying in the home for as long as it takes to recoup your closing costs (your “breakeven” point) and recognize some savings. Depending on the closing costs and the amount you are refinancing, this could take a year or even longer.

The bottom line: if you are potentially considering a move in the short-term, (the next two to three years, say), a mortgage refinance may not make sense for you.

After evaluating the four action items above, you may determine you are ready for refinancing and that you’d save a lot of money by doing so. But don’t wait too long – while industry analysts predict interest rates to remain low for another year or so, even a slight variance in interest rates can cost thousands.

• For example, the average interest rate for October 2020 is 2.625% on a 30-year fixed rate. This means someone with a $500,000 loan would pay $80,000 in interest over 30-years.
• Another individual waits a month until December 2020 and gets an interest rate of 2.825%. Even though this is only slightly higher, the difference costs an additional $47,000 over 30-years on the same $500k loan.