Even though a drop in interest rates can make the idea of refinancing a new mortgage seem to make good financial sense, that's not always the case. Though it's generally possible to refinance at any point after getting a mortgage, sometimes it's a bad idea for your wallet, even with an interest rate drop.
The Ability to Refinance
Borrowers can apply to refinance a mortgage any time after the loan closes and refinancing again and again is entirely possible as long as the borrowers are eligible based on credit scores and the loan-to-value ratio of the home. Refinancing quickly (less than six months from the closing of the loan) may require the borrowers to seek out a new lender as some mortgage lenders will not refinance mortgages that were closed by them within the last six months. This isn't a mortgage law, but rather a preference of the lender.
Loan-to-Value Considerations
Refinancing a loan that has higher than an 80 percent loan-to-value will likely result in the inclusion of private mortgage insurance, which will be an additional monthly cost above the principle and escrow payments. For some borrowers, this makes it not worth it to refinance.
Closing Costs
A refinance might result in another batch of closing costs; ensure any savings realized by the refinance in the form of a lower interest rate or shorter amortization are not cancelled out by the total closing costs. While some lenders require closing costs to be paid out of pocket at closing, others allow borrowers to roll the costs into the loan (thereby creating a situation where borrowers are paying interest on their closing costs long after the loan has closed).
Interest Rate Considerations
The general rule of thumb among mortgage professionals is that a 1 percent interest rate drop merits a refinance. While it's true any interest rate drop will save money over the life of the loan, the closing costs and "starting over" of payments may make it to where it's not worth it financially. Note that those with higher-than 80 percent loan-to-value ratios may not be eligible for advertised refinance interest rates as mortgages above that ratio are considered riskier and therefore may be charged a higher rate.
Prepayment Penalty
Though not as common as they once were, prepayment penalities might make a refinance a bad idea. If your lender will charge you a hefty fee for paying off your mortgage early, take a critical look at that cost versus your potential savings.
Shorter Amortization
Refinancing to reduce the number of months it will take you to pay off the mortgage (such as going from a 30-year to a 15- or 10-year mortgage) can save thousand of dollars in interest over the life of the loan and is a good financial move even without a full 1 percent interest rate drop. Of course, you should expect a higher monthly payment when reducing the amortization, but the overall savings will be substantial.
From ARM to Fixed
If your adjustable rate mortgage (ARM) is on the precipice of adjusting and you fear the increase will be problematic, a refinance to a fixed rate mortgage can make sense, but only if you can find a lower interest rate with a fixed mortgage, which is unlikely unless your credit score or equity has increased substantially.
Removing a Name
Refinancing a mortgage to remove a name from the mortgage and title, such as with a divorce, can happen at any time, but you are still subject to the considerations above. And though it may be a stressful time, borrowers should still strive to find the best deal and terms possible to avoid paying more than they should over the life of the loan.
Beyond Interest Rates
Refinancing is about more than the interest rate, although interest rates should be a major consideration. Amortization, fees, penalties, and what's best for the future financially should all be considered.
