If you’re considering refinancing your home mortgage you may have heard of the “two percent rule.” This rule states you should never refinance your mortgage unless the interest rate of the new loan is at least two percent lower than the mortgage rate on your existing loan. Is the two percent rule good advice?
The two percent rule of mortgage refinancing is actually terrible advice. Instead of looking for a mortgage rate that is two percent lower it is better to evaluate your refinancing options on a “cost per savings” basis.
What is cost per savings? Simply put, you are evaluating how long it will take to recoup your expenses from refinancing with a lower monthly payment amount. This assumes you are refinancing for a lower payment; however, there are several good reasons for refinancing with a higher payment. Higher monthly payments are a topic for another article.
Suppose you are refinancing your home and your total closing costs including origination fees are $4,000. The new mortgage payment is $150 lower. To determine how long it will take you to recoup your expenses from refinancing divide your costs ($4,000) by the difference in payment amounts ($150) to determine that it will take you 27 months to recoup your expenses. ($4,000/$150=26.6) This is just over two years before you will realize any savings from the new mortgage.
Whether or not you’re okay waiting two years to get your money back from refinancing depends on your situation; however, it’s not uncommon to wait five years or even longer to recoup your expenses. One factor to consider when making this decision is how long you plan on keeping your home. If you refinance or sell before paying back your expenses you will lose money by refinancing. You can learn more about your mortgage refinancing options, including expensive pitfalls to avoid with our free mortgage toolkit.