Deciding whether or not to refinance a mortgage can be stressful, especially when interest rates are on the rise.

While many homeowners may have already missed out on the chance to refinance to a lower rate, others could still benefit from a refi today. Nearly 1 million owners would be able to reduce their current interest rates by at least 0.75 percentage points, according to mortgage analytics company Black Knight. These homeowners could save an average of $316 per month, equal to $3,729 per year.

Most mortgage experts recommend trying to reduce your rate by at least 0.75 percentage points (from 6.50% to 5.75%, for example) to make it worth the cost of a refinance. Naturally, the higher the rate reduction, the more money you'll save over time. However, a rate reduction of as little as 0.50 percentage points could still be worthwhile.

With mortgage rates expected to continue to rise in the near future, now may be the best time to go over your options and see if a mortgage refinance works for you. If you're not sure where to start, the following steps can point you in the right direction.
 

If your mortgage rate is above 6.13%, now is probably a good time to refinance

The current average mortgage rate for a 30-year fixed-rate loan is 5.13%, according to Freddie Mac. It is probably worth considering a mortgage refinance if you can reduce your current interest rate by at least 0.5%.

If you have a $300,000 balance on your mortgage and you refinance to a new 30-year loan, lowering your interest rate from 6% to 5.50% will save around $95 per month or $1,140 per year. If you can reduce the rate from 6% to 5%, your monthly savings would be $188 per month or $2,256 per year.

You also don’t have to refinance into a 30-year loan. If your finances have improved and you can afford higher monthly payments you can refinance a 30-year loan into a 15-year fixed-rate mortgage, which will allow you to pay the loan off faster and also pay less interest.

Taking a look at your monthly savings is just one part of the refi equation, however. You also need to factor in the cost of switching out your loan and how long it will take you to recover those costs, or ‘break even’.

Just as with a purchase loan, you’ll have to pay closing costs on a refinance. These costs can include origination and applications fees, appraisal and inspection costs and title search fees. In all, closing costs can run between 3% and 6% of the total loan amount being refinanced.

You can determine your breakeven point by dividing your total closing costs by the amount you’ll save each month. The result is the number of months it will take you to recoup the refinance cost and start saving money. The less time it takes to break even, the more sense it makes to refinance your home loan.

The final piece of the refi puzzle is balancing your refinance goals with the change in the length of the loan. For example, if you are 10 years into a 30-year mortgage, refinancing into another 30-year loan means you’ll be paying a mortgage for 40 years instead of 30.

If your primary reason is reducing your monthly payment, refinancing into another 30-mortgage makes sense. However, if your goal is to save on interest and reduce the term of your loan, then refinancing a 30-year into a 15-year mortgage may be the better option, as long as you can afford the higher monthly payments. Use a mortgage refinance calculator to get a sense of what might work for you.
 

Are mortgage refinance rates still low?

When the COVID-19 pandemic first hit in March of 2020, the Federal Reserve devised a monetary policy to help stabilize financial markets and soften the economic impact of the virus.

That included reducing the federal funds rate — the interest rate banks charge each other for short-term loans — to near zero. The Fed also pledged to purchase $40 billion worth of mortgage-backed securities, and $80 billion in Treasury notes and other financial instruments per month. These moves pushed mortgage rates below 3% for the first time in history.

However, with employment improving but inflation rising, the central bank began pulling back on its tight monetary policy in late 2021. The Fed has been reducing its purchases of Treasury notes by $10 billion each month and of MBS by $5 billion per month. In June 2022, Fed policymakers announced they would increase the federal funds rate by 0.75 percentage points and expect more rate hikes this year.

Since the beginning of 2022 rates have jumped substantially and are currently averaging 5.13%. Still, if you’re considering a refinance, it may be best to act sooner rather than later. Most economists agree that mortgage rates will increase further.
 

How to know when to refinance your mortgage

Here are some key points you should consider when deciding whether to refinance your mortgage:

• Your credit score. With most mortgage lenders, you’ll need a credit score of at least 620 to qualify for a mortgage refinance. To get the lowest mortgage rate, you’ll need a 740. Also keep in mind that, if your credit is lower than it was when you took out your current mortgage, you may not qualify for as favorable a rate as you did before.
• Your debt-to-income ratio (DTI). For conventional loans, some lenders will work with a DTI as high as 43%. FHA loans will go a little higher, usually accepting DTIs of 50%. Lower, however, is generally better.
• How long you’re staying. When you refinance, you’ll need to pay closing costs. If you plan to move out in the near future, you may not break even.
• How much equity you have in your home. In order to qualify for a mortgage refinance you generally need at least 20% equity in your home.

Don’t try to time the market. Waiting on rate swings is as troublesome as timing the stock market. Don’t wait to see what happens with mortgage rates tomorrow if you can save money or move closer to your financial goals by refinancing today.