When Is the Right Time to Refinance Your Mortgage?

With mortgage interest rates falling, and rumors that the Federal Reserve will cut the federal funds rate in September, there are a lot of people already thinking about refinancing the mortgages they're paying 7% for. Before you make the leap, though, there are a lot of things to consider.

Here are a few ways to know it's the right time to start checking out refinance rates.

1. You've decided to stay in your home for a long time

Refinancing your home's mortgage is generally about getting a better interest rate, but sometimes it doesn't actually pay to make the leap to a new mortgage. The average homeowner is now in their home for 11.9 years as of 2023, but if you don't plan to stay long, it might not be worth it.

A refinance on average, according to Freddie Mac, costs about $5,000. That's money that will either come out of your pocket or pile on top of your mortgage.

So, let's say your refinance saves you $100 per month when all is said and done. You would need to be in your home for 50 months beyond your refinance simply to break even, and that doesn't include the fact that you essentially lost all the interest you already paid to your original mortgage.

However, if you can make your day-to-day living more affordable, it can make sense to choose this option regardless of any previously sunk cash.

2. You need to get out from under your mortgage insurance

For some FHA mortgage loan borrowers, mortgage insurance stays for the life of the loan and can only be shed with a refinance to a conventional loan. It's not possible to lose mortgage insurance until you have at least an 80% loan-to-value ratio, meaning that your home has 20% or more in equity that's free and clear. So you'll be paying that mortgage a while before you reach the point where that's even possible simply by making payments.

If you bought a house that was worth $425,000 with a 5% down payment at 6.5% interest, you would have to pay down the loan to $340,000 to reach the point where you could refinance to remove the mortgage insurance. This won't happen until midway through year 10.

If you pay mortgage insurance for the entirety of those 11 years, you'd have paid $20,520 -- or about $155 per month (mortgage insurance varies based on how much outstanding principal you owe and decreases as you pay your mortgage down).

While that sounds like a lot, hanging onto the mortgage to avoid losing those sunk costs will cost you even more -- a total of $39,612! By holding onto your note to avoid refinancing your mortgage insurance, you'll spend an extra $19,092 over its lifetime. If you plan to stay in your home and pay the mortgage off, this is generally a solid move, since the average refinance only costs about $5,000.

3. Interest rates have dropped dramatically and you still owe a lot

This is unlikely but it's possible, so let's explore it. Let's say you just bought your house and the interest rate was 7%. It's the same house from above, the $425,000 one with a 5% down payment (meaning you've borrowed $403,750). Holding on to this loan for its lifetime means paying $563,267 total in interest across 30 years. It's not nothin', as they say.

But because mortgage interest is essentially front-loaded, meaning you pay the most in the beginning of the loan and less as time goes on, refinancing early in the loan is better than waiting until deeper in to do so.

In the sample loan, you're paying $28,132.57 in the first year in interest alone, and just $4,101 toward the principal. By the end of year three, you've paid $83,486 and owe $390,535. If you refinance now, at 5%, you'll pay an additional $364,196 for the next 30 years of interest, totalling $447,682 -- saving you over $115,000 in interest.

But let's say it takes a while for rates to come down. At the end of year 10, you've paid $265,056, or about 47% of the interest you're gonna pay. You still owe $346,467 in principal. At this point, even refinancing to a 5% interest rate means you'll pay an additional $323,101 for the next 30 years of the mortgage, totaling $588,157 in interest payments, plus the cost of refinancing.

The right time to refinance your mortgage depends on your circumstances

I know it's such a cop-out to say the right time to refinance is when it's right for you, but that's honestly the truth. Some people need a lower payment to ease their budgets, even if it means a longer time to pay the loan off. Some people need to get rid of mortgage insurance and have no options. Some people simply get lucky and should definitely take advantage of their timing.

So when the Fed announces rate cuts, don't get too excited. Just take a big breath, and focus on what's most important to you for your mortgage and stay the course.