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Since rotisserie chickens in the 1950s, setting and forgetting has become a way of life. The approach has extended beyond meal prep to retirement planning and even mortgages. Since payments typically stay the same, your mortgage is easy to set and forget. However, a small tweak to your largest liability can make a big difference to your cash flow and overall net worth. We urge you to review your mortgage every year or two to make sure it is at least still competitive in the current interest rate environment. If not, you may want to consider refinancing.
When does it make sense to refinance? If interest rates have decreased by 0.5% or more, then it might make financial sense (and be worth the time) to refinance. Use an online calculator to estimate what your new payment would be if you refinanced. Compare your new payment to your current payment to determine your potential savings. Keep in mind that refinancing isn’t free so it’s important to weigh the costs of the refinance against the savings. To do so, divide the cost of the refinance by the amount you will save each month.
Example: Let’s say that a refinance would save you $150 a month. If the cost to refinance is $2,000, it will take you a little over 13 months to ‘break-even’ on your refi ($2,000/$150 = 13.33 months).
In general, if the break-even is less than 24 months and you plan on staying in your home at least as long, then a refinance makes sense. Note that most lenders will require you to intend on living in the home for at least two years after a refinance to qualify for primary residence interest rates.
If you have had your mortgage for a long time it might not make sense to refinance, even if rates have dropped substantially. To understand why, you need to understand how amortization works. In the beginning, most of a monthly payment is applied to satisfying interest on a loan, with a very small portion applied toward principal. Over time, this trend reverses with more of a payment going towards paying down principal and less towards interest. With a refinanced loan comes a new amortization schedule, again, with most of a payment going toward interest, effectively prolonging the payoff of principal. Still, if you are nearing retirement, review your entire financial situation to see if a refinance makes sense. Refinancing may provide a way of tapping into your home equity while you still qualify, even if your mortgage is seasoned and interest is a small portion of your payment.
