The “Experts” Say…“Rates need to be 2% lower to justify refinancing.”
Ever hear something like this and take it at face value? In the mortgage business, we hear recitals of old rules all the time. They often come from so-called experts, but frankly, there are times when their advice could lead you down the wrong path.
The first problem with this rule: It started as a basic “rule of thumb” and was not usually properly quoted. The entire rule was: “Rates should be 2% lower if you intend to stay in your home for three years or less and 1% lower if you intend to stay in your home for three years or more.”
The second problem with this rule: It is hopelessly out of date. It goes back to a time when average loan amounts were much smaller and the fees as a percentage of the loan amount were much higher.
Follow the rules of math instead. Simply calculate whether the costs paid to refinance can be recouped through monthly savings during the time you plan to live in your home. The larger the loan amount, the more even a small difference in rate can matter.
For example, with a larger-than-average loan amount, reducing your interest rate by just one half of one percent could equal savings of more than $100 per month. If you spend a few thousand dollars in closing costs, the payback period will be only a few years.
The longer you have the new loan, the more the savings add up. A $1,200 per year savings could grow to tens of thousands over the life of the loan. If you apply your monthly savings to your principal, you will save even more on interest and own your home sooner.