You can refinance your mortgage as soon as you want after closing on your purchase mortgage. Most loan programs don’t have a specific period that you must keep the loan.
Should you refinance your mortgage right away, though? It’s probably not the wisest decision. We’ll help you understand the reasons below.
Make Sure You Don’t Have a Pre-Payment Penalty
First, no matter what type of loan you have, make sure you don’t have a pre-payment penalty. They are fairly rare today since most lenders don’t use them. The mortgage guidelines that were passed down after the mortgage crisis pretty much eliminated the prepayment penalty, but you can’t be too sure. Read the fine print on your mortgage documents to make sure paying your mortgage off early won’t cost you extra money.
Does It Make Financial Sense to Refinance?
Here’s the real question? Does it make sense to refinance? Sure, it sounds great to lower your interest rate even 0.5%, but is it worth it? How much will you really save each month? On top of that, how much will it cost you to get that lower rate? That’s the real issue. Most mortgage loans have closing costs. These closing costs take away from the savings you’ll earn from a lower interest rate.
The best way to tell if it’s worth it is to figure out your break-even point. This is the point that you pay off the closing costs and can pocket the savings from your lower payment. All that you need to figure out your break-even point is the total amount of the closing costs and the monthly savings on the new loan.
Once you have these numbers you can do the following calculation:
Total closing costs/Monthly savings = Number of months to break-even
What’s a good break-even point? It really depends on your personal situation. Is this your forever home? If so, then a longer break-even point may be acceptable. If you plan on moving in a few years, you’d need a short break-even point for refinancing to make any sense for you.
Do You Want to Pay Closing Costs?
When you bought the home, you probably paid between 2% and 5% of the loan amount in closing costs. On top of that, you paid your down payment. If you refinance, you won’t need to make a down payment, but you’ll likely pay closing costs. Do you want to cough up a few thousand dollars again, so soon after buying the home?
You may be able to get a no-closing-cost refinance, but that means you’ll take a higher interest rate. Lenders usually charge 0.5% more in an interest rate in order to take care of your closing costs. Usually, closing costs are like prepaid interest to the lender. Any fees you pay directly to the lender is money the lender makes up front. This way they can charge you a slightly lower interest rate for the life of the loan. If you don’t pay those closing costs upfront, the lender takes a big risk and needs to charge the higher interest rate to make up the difference.
Do You Want to Restart Your Term?
Another issue you have to consider is restarting your term. Let’s say you took out a 30-year loan. If you haven’t made many payments on the loan yet, refinancing won’t have that much of a financial impact on your loan.
On the other hand, even if you’ve paid just two years into your loan, you’ve knocked off 24 payments already. If you refinance into another 30-year loan now, you’ll add those two years back onto your loan. That’s another 24 payments and a lot more interest. If you do refinance, try to get a term that is close to the time you have left on the mortgage, if not less time. Why not save even more interest if you can?
Special Mortgage Requirements
Certain mortgage programs do require you to wait a certain amount of time before you can refinance. One such example is the FHA streamline refinance. The other is the VA streamline refinance. Both programs have very relaxed guidelines, but because your approval relies on your mortgage payment history, you may need to wait 12 months before you can refinance. There may be some instances where a lender can grant an exception, but it’s on a case-by-case basis.
Generally, you should wait to refinance until the savings are enough to make up for the closing costs you have to spend. Ideally, you should pay off those closing costs in 2 – 3 years, if possible. If it takes much longer than that, you may be better off waiting.