Should You Refinance Your Mortgage?

On March 15, The Federal Reserve dropped the federal funds rate to 0-0.25%, which then sent average mortgage rates to 50-year lows, with an average 30-year mortgage around 3% (Source: FreddieMac.com).

So what does this mean for someone with a mortgage? When does it make sense to refinance?

There are two rules of thumb that I like to start with:

1. Can you drop your interest rate by 1%-2%?
   
2. Can you pay off your closing costs within a year or two? (Average closing costs range from 2% to 4% of the loan.)

For example, let us take a $200,000 30-year mortgage at 5% with a monthly payment of $1,074 (before taxes and insurance). If refinanced at 3%, we have an $843 monthly payment, or $231/month savings. And with closing costs of $4,000 (2% of the loan), it takes 17 months to break even ($4,000/$231). This is compelling. Not only does it drop the payment, but it only takes 17 months to break even on closing costs.

GET THE LATEST UPDATES: Download the free Tennessean app on your mobile device

As a note, while it may technically make sense on paper to refinance even if a break even is not reached within the first year or two, it can be difficult to predict the long term. For example, your job may change next year and you may decide to sell your house. This is why I usually encourage folks to refinance if they can break even in the short term.

There are many other things you may want to consider when refinancing, such as changing from a variable rate to fixed rate, locking in a shorter term, or changing the amount of the loan.

Every situation is different, so consider reaching out to a mortgage broker or financial adviser to see what makes sense for you.

Hunter Yarbrough, CPA, CFP, is an executive vice president and financial adviser with CapWealth. He is passionate about taking a holistic view of personal finance, including investments, taxes, retirement, education, estate planning, and insurance. For more information about Hunter and CapWealth, visit capwealthgroup.com.