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When to Refinance

Is Now the Time to Refinance?

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When rates go down, refinancing may be tempting. But when should you refinance and when should you hold off?

When Refinancing Makes the Most Sense

Refinancing is generally a good idea when it will save you money, or when it will somehow improve your situation (even if it costs money). A few examples of good reasons to refinance are:

  • Get a lower interest rate or shorter loan repayment term after rates have dropped
  • Eliminate a second mortgage that has a high interest rate
  • Qualify for a better mortgage after your credit has improved
  • Apply with higher income (either because your pay has increased or you can add a spouse’s salary to your household income) and get better terms
In all of the examples above, it’s important to make sure that you’ll actually improve things. Getting a lower monthly payment does not necessarily save you any money. It improves your cash flow situation, but it can actually result in higher total interest costs over your lifetime.

For more details on whether or not you’ll really save money, see Should I Refinance?

Refinance Before You...

If refinancing is important to you, make sure to get your refinance approved before applying for other loans. Your credit gets dinged a little bit every time you apply for a loan (this is called an inquiry), and you need your credit to be as good as possible when you refinance.

After your refinance is completed, go ahead and buy that car or apply for that credit card. It’s less likely that the refinance will negatively affect those loans (after all, you already had a loan -- you just swapped it out for a new one). The one exception to this might be if your monthly payments are going to increase after you refinance. If, for example, you want to switch from a 30 year mortgage to a 15 year mortgage, your monthly payment may go up (but you’ll spend less on interest). Depending on your debt to income ratios, this higher payment might make it difficult to get loans after you refinance. On the other hand, if you get the auto loan before refinancing, you might not be able to refinance. Choose what is most important and get that loan taken care of first.

It’s also a good idea to refinance before changing jobs. Lenders like to see stability and a consistent source of income. The longer you’ve worked at your job, the better. This doesn’t mean you can’t refinance after taking a step up (or even a step down, depending on your credit and other factors), but it’s best to apply for a loan when you’ve been with the same employer for a while. In addition, it’s much more difficult to get a loan when you’re self employed; if you’re headed down that path, you should certainly try to refinance before you quit your day job.

Timing and the Economy

Refinancing is most attractive when interest rates fall. Lower rates mean lower interest costs and lower payments (unless you extend your loan by getting a new 30 year loan, for example, which would result in higher interest costs). Sometimes you can even get a shorter term loan without much of a change to your monthly payment.

But when is the right time to pull the trigger? Should you do it now, or wait for rates to go lower? It’s really impossible to know the answer, and trying to get too fancy is dangerous. In general, you should refinance once you decide that it makes sense to do so. You don’t need to break your neck trying to close a deal quickly, but you shouldn’t drag your feet either.

Rates will always go up and down. They may drop right after you refinance, and that’s unfortunate. But things could always go the other way. Control what you can control; refinance when you see an opportunity to improve your situation, and don’t get hung up on getting the timing just right -- it’s impossible to see the top or bottom of interest rates until after the fact. Sometimes you’ll get lucky and sometimes you won’t, but things will most likely balance out over the long term.

When Not to Refinance

When is it a bad idea to refinance? There are several situations you may find yourself in that make it less advantageous to get a new loan.

Refinancing makes the most sense if you’ll keep the loan for a while. You have to pay closing costs when you refinance; even if you don’t write a check, they may be added to your loan balance. That money is wasted if you retire the loan shortly after refinancing (by refinancing again, or by selling your home and paying off the loan, for example). A breakeven analysis can help you figure out how long you need to keep the loan.

Prepayment penalties can also wipe out the benefits of refinancing. Find out if you’ll have to pay a penalty, and run some numbers to see if it still makes sense. Prepayment penalties are less common than they used to be, but they still exist on some loans.

Now that you have a better feel for the timing, find out how to refinance.

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