Is There a Rule of Thumb for When to Refinance a Mortgage?

A Better Rate

Use the 2 percent rule when it comes to interest rates. That is, if the interest rate on a new mortgage would be two percentage points or more lower than your current rate, you should definitely think about refinancing.

Although an interest rate may be lower, there are usually costs associated with closing a new loan. The term "break-even point" is used to describe the point at which the reduction in interest payments equals the cost of refinancing. For example, if you are able to reduce the interest rate on a $200,000 mortgage from 6.5 percent to 4.5 percent at a refinancing cost of $2,500, it would take almost exactly 10 months to save enough on interest to pay for the closing costs. This is the break-even point. A recommended break-even point is two to three years for most mortgages. Use an online mortgage calculator (see Resources) to determine your break-even point.

If you have an adjustable-rate mortgage that is within a percentage point of a fixed interest rate, and you plan to be in your home for more than a couple of years, consider refinancing into a fixed rate.

Another aspect to consider is debt consolidation. If you are carrying a lot of debt at an interest rate substantially above the rate charged on your mortgage, refinancing might make sense even if the mortgage rate improvement is less than two percent. Credit cards, for instance, frequently carry rates double or triple that of a mortgage rates. If your credit debt is substantial, a refinance may lessen your overall interest payment.