When to Refinance a Mortgage with Lower Interest Rates

These are the days of low interest rates, sometimes the lowest rates people have seen in their lifetimes. It’s a far cry from the double digit interest rates people were paying in the 19080s. But when should you refinance your mortgage with these lower interest rates?

Most people’s first reaction is – right now as soon as possible. The reason for this is that if you are paying 8% interest on your mortgage and the current rate is 4%, you can save a whole lot of money if you refinance at the lower interest rate and pay the lower rate for the life of the mortgage. For example if you have a 20 year mortgage for $200,000, at 4% it would be one third cheaper per month than at 8% interest – to the amount of about $400. However there are times when it is not the best idea to switch right away.

The right away answer can be especially true if you have a variable rate mortgage and interest rates will be rising shortly. Most people get a fixed mortgage that guarantees their interest rate for the five to ten years of the term, but they pay a bit higher interest rate to do that. Also if the rates go down, they do not benefit from them. However, a variable interest mortgage can quickly go above where you can afford the payments if you are not careful. In the 1980s interest rates were double digits, and if interest goes from today’s 4% to say 12%, your monthly mortgage payments on a $200,000 20 year mortgage would go up 75% or over $900 a month! If you have a variable rate mortgage, make sure you lock in a low interest rate before the rates get too high for you to afford!

If you have a mortgage right now, there is a very good chance that you will have to pay a penalty if you break your mortgage early. If you have a five year mortgage, and change to another mortgage at say the four year mark you will have to pay that penalty. Some banks may offer to pay that penalty for you just to get your business, but if they don’t you could be on the hook for some very hefty fees. It’s not unheard of for the fee to be based on how long you had to go, and how much money the bank will lose when you switch over – possible $2000 or more! If this is the case, the earlier example of saving $400 a month wouldn’t happen until you pay off those fees which would take 5 months. In that case, its almost like every month you hold off you are saving $400. But during that time the interest rates could go up or down – you are taking a chance by waiting.

How is your credit rating these days? It is possible that you got your mortgage when your credit rating was good, which enabled you to get a low rate. If since then you have had credit problems, you will pay a much higher rate if you refinance your mortgage. Many people don’t think about this before trying to refinance their mortgage and get a big surprise. This is easily solved by just getting a credit report so you know what your credit history is before going to the bank.

Assuming that you have great credit, and you can refinance without penalties. Are there other things to consider at this point?

Your mortgage is one of your lowest interest debts you will ever have. This is because the bank secures your mortgage against the value of your house – if you have problems making payments, the bank simply takes your house and sells it to get their money back at little or no risk to them. The fact that your mortgage is low interest makes it a great way to help you pay off your higher interest debt such as credit cards. If you have a department store credit card you might be paying 30% interest on it per year, compared to that 4% on your mortgage. If you carry a large balance, that is a lot of money paid out in interest. If you have paid off enough of your mortgage you will have room to move your credit card debt into your mortgage and save that interest. For example if you owe $5000 on a credit card at 30% interest that is $125 per month in interest, but if you change your $195,000 mortgage to a $200,000 when you refinance you will be paying under $17 per month in interest on it. Ideally you should use that savings of $108 per month to pay down your mortgage faster, but it’s up to you. Remember that to do this, you need to have paid off enough of your mortgage that the bank will let you do this.

In most cases the answer to when to refinance a mortgage with lower interest rates is right now, but there are some exceptions to that rule. Plus when you refinance consider moving your high interest debt to your new lower interest mortgage.