Why Should I Refinance: Answering Why Should You Refinance (Or Not)

Those asking “why should I refinance?” are often wondering about interest rates, home values, and loan terms.  In this post we tackle that question “why should you refinance?” by looking at those factors and more.

Why Should I Refinance: Home Values

When asking “why should I refinance” as it relates to home values you need to understand the relationship between home value and rates.  Start with the fact that most everything we own can be valued at a certain price.  If you want to sell your microwave, you can probably easily find out how much to sell it for.  The same goes for your car, your old fitness equipment, and your used textbooks.  The price for these items will not change much over the next month or 90 days or even longer.  Logic would say the same would hold true of your home – its an object so it should be worth whatever its worth, no strings attached.

Unfortunately, valuing your home is just not that simple.  Most home buyers will need to take out a mortgage to buy your home, the what they can afford to pay is often more tied into how much they will pay each month or each year than what the listed price is.  In other words, many home buyers have to think about what the mortgage payment will be, not just what the sales price is.  And thus the whole pricing game can be tied to mortgage rates.  So, for example, if someone can afford a $2,500 mortgage payment they may be able to pay $450,000 for your home when rates are 5%, but if rates are 7% they may only be able to pay $400,000 to have that same payment.  When rates are low you may be able to ask for more for your house than when rates are high.  Some may dispute this, but for many buyers it is quite true.

Why Should I Refinance when interest rates are low?

Given the above it may be that when interest rates are low, asking prices for houses are higher…but there is one caveat: Sometimes interest rates are low because the economy is sluggish.  And if the economy is sluggish people cannot afford as much for houses and therefore home prices will be depressed.  The opposite is also true, that sometimes when the economy is strong interest rates are a little higher and people can afford a bit more.

Long story short: the relationship between interest rates and home prices is complicated, and the only way to price your home for a refinance is through recent comps which may be affected by rates.  If you are asking “why should I refinance?” you may find that when rates are low your home’s value gets a little deflated.

When Should I Refinance: Future Plans

When asking “why should I refinance my mortgage?” you also need to keep in mind your future plans as they relate to the home in question.  Home refinance loans differ in many important ways beyond the interest rate you are offered.  Thus you will need ways to compare each possible refi loan effectively when it comes to closing costs.  The best way to compare each refinance loan is to look at the amount you’ll pay including closing costs over the course of time you are likely to live in that home covered by the mortgage loan.  If you have an idea that you might move in five years, two years, or never, you can calculate the total amount you’ll pay on the mortgage including closing costs in those time increments.  As has been said here many times, closing costs on the refinance may only be worth paying if your plan is to stay where you are for a long time (personally I don’t like predicting whether I’m going to refinance again, but that amount of time would be the same thing, for these purposes, as moving).  In other words, $5000 of closing costs may not be worthwhile if you are going to move in two years (and you’ve then basically spent $2,500/year) rather than 10 years (when you’ve spent $1,000/year).

Why should you refinance and comparing payments

The worst way to compare refinance loans is to compare payments…though many mortgage brokers and banks will lead you in that direction.  Comparing mortgage payments after the refinance negates the effect of closing costs and, in the case of refinanced mortgages, does not take into account the months or years you’ve already paid the note down before the refinance (I’ll spare you the math – trust me on that one).

Why Should You Refinance: Rates

Perhaps the most common question mortgage brokers and banks get from customers trying to decide when to refinance is “Why should I refinance my mortgage if it’s only a ___________ reduction in rate?”  The answer can be complicated, but what people do need to understand is that if they are asking the mortgage broker or bank they are certainly asking the wrong person.  As we’ve stated many times, these people are in the industry and although the vast majority are honest and hard-working people like me and you, they cannot likely completely shake their biases when it comes to when to refinance.  Their lean will always be toward “yes”.

Why should you refinance calculations

So, when you will only save a small percentage, what is the answer to the question “Why should I refinance?”  There are basically three calculations to make:

1. First, add up all closing costs that you will pay out-of-pocket.  Do not include anything like taxes and prepaid interest that you would pay on your existing mortgage anyway.

2. Now here is the part most people leave out when figuring out when to refinance: Take that number and use an online calculator to determine how much it would be worth at current interest rates if you left it in the bank.  You see, that money would not just stay the same over time, but rather would actually grow in value if used for a different purpose.

3. Now compare that higher number – called “future value” – with the savings you will have on your mortgage each month x the number of months (conservatively) that you will likely live in that home.  If the savings are appreciably greater, by enough to make the effort worth it, then it may be that you have your answer to the question, “When Should I refinance my mortgage?”

Knowing when to refinance can be easy during times of significant rate drops, but the above can be helpful when rates only drop in smaller increments.

Of course we have other similar resources including our page about “When should you refinance?”, our page about getting low refinance rates, and our page about “How Do I Refinance My Home?”

There are of course other factors that are important as well as far as the answer to “why should you refinance?“.    We listed these three examples that may help you decide your own answer to the question “Why should I refinance?”