Mortgage refinance loans come in a wide variety of shapes and sizes – from streamlined rate reduction loans to cash out/home equity mortgage loans, there are a lot of different reasons to consider a refinance, and each of them has a different answer to the question “when should I refinance?”. We try to break down some common myths and explain when it’s a good idea (and when it’s not!) to refinance your mortgage.

We’ll look at some different types of refinance mortgage loans, and discuss when it makes sense, or not, to consider refinancing your home.

The Streamline. (FHA Streamline Refinance, VA IRRRL)

Some government loan products offer customers a fast & easy refinance option designed for home owners looking to just reduce their interest rate. The FHA Streamline Refinance and VA IRRRL (for Veterans with a VA loan) come with “credit qualifying” and “non-credit qualifying” varieties – with some slight variations between the 2, the gist is that customers can refinance without an appraisal, including a limited set of closing costs into their new loan, while obtaining a new, reduced interest rate.

The big benefit of these products is they often offer some of the most competitive rates in the market without as much emphasis or variation to rates based on credit scores. Borrowers can score (pun very much intended) a great rate with even average-good credit.

The Pitfall: Streamline loans can come with some ‘cons’. Sometimes lenders try to lure customers with extra low rates but fail to explain the total set of fees associated with the loan. VA IRRRL loans offer some protection with a rule requiring loans reduce a monthly payment enough for a borrower to recoup their closing costs within 36 payments. Even with that protection, fees can be high, and sometimes in a market where rates are falling, it can make the most financial sense to simply wait.

The Rate Reduction (And That Silly “1% Rule”)

One of the most common reasons to refinance is to simply get a lower rate and payment. As markets change and rates fall, customers who obtained their mortgage while rates were higher (hello 2022-2024 home buyers) look to get a new loan at a lower rate. This is called a “rate/term refinance” or a “no cash out” refinance.

Some people believe there’s a ‘rule of thumb’ that you need to reduce your rate by a full 1% or 2% for a rate/term refinance to make sense, but the reality is that there is no such rule. Consider this: A 1% reduction in rate for someone with a $100,000 loan is just a $63/month savings (going from 6% to 5%), but with a $600,000 loan, going from a 7% to 6% (the same 1% drop) equals a savings of nearly $400/month. And since closing costs are mostly fixed (some fees vary slightly based on loan amount, but most are standard/fixed costs), the “break even” on each loan is drastically different. So for that person with a $600,000 loan, it might make sense to consider a refinance with a rate difference of just .5%.

Since monthly savings and the impact it has on finances is different for everyone (to some people, $50/month offers some serious relief, while for others, a savings of $300/month is where they start to feel good about things), there’s no right or wrong answer on when to do a rate/term refinance, BUT, it’s important to keep some things in mind:

• Closing costs should be recouped relatively quickly. “Relatively” is different for everyone, but especially in a market where rates are falling, it usually makes sense to keep closing costs as low as possible until the market finds it’s bottom
• A low rate looks great, but if the low rate costs excessive fees and points, it may not be worthwhile
• Despite mortgage marketing gimmicks, there’s no such thing as “skipping a payment” – mortgage interest is paid in arrears, so while it’s true that you typically won’t have a mortgage payment due the month following a refinance (eg if you refinance mid-April, the first payment due date is June 1), that June payment is paying all of May’s interest, and you’ll pay the mid-April to end of April interest as part of closing costs)
• A good loan officer will show you multiple options with different rates and cost structures to determine which option works best for your unique situation

The Pitfall: Costs can be high for a refinance, and vary a lot by state. Some states have state taxes they charge when refinancing, and in some states title insurance can be expensive, so it’s always a good idea to do a thorough analysis of savings VS cost to see if a no-cash out refinance makes sense for you.

The Cash Out Refinance

One of the big perks of home ownership is the appreciation that typically comes with owning a home. Over time you build equity through market appreciation and paying your principal loan balance down each month. One way to access that equity is to sell your home. But if you need cash while you still live in the home, you can access it via a cash out refinance. Cash out refinances are used for a variety of reasons, but home owners may tap into equity to borrow money to pay off other debts that have higher rates or payments. Others may use home equity to finance home renovations. Regardless of the reason, the equity in your home can be accessed via a cash out refinance, usually up to 80% of the home’s total value (for conventional and FHA financing – VA borrowers can access up to 100% of the home’s value!).

Mortgage debt offers some major cash flow perks in that it tends to come with lower rates than personal loans or credit card debt, and offers longer loan terms (30 years being the most common) so that using mortgage equity to pay for something like a car loan can drastically improve monthly disposable income. For example, a $50,000 car loan with a 60 month term at 6% comes with a $900+/month payment, that same amount financed into a 30 year mortgage at 7% comes out to $332/month. We’re not saying it’s a good idea to stretch a car loan over 30 years, but if you need to improve your monthly cash flow, home equity may be able to help!

The Pitfall: You don’t want to get into the habit of using your home as a piggy bank. You need to be very smart about how and when you tap into your equity because it can be expensive to do so. Cash out refinance rates also tend to be a little higher than rate/term refinance rates. In many instances, especially for those who lucked out with an interest rate on their first mortgage in the 2s and 3s (hello 2020 and 2021 home buyers), an alternative option like a HELOC or HELOAN (see below) is a cheaper, and ultimately better, option.

The HELOC/HELOAN

An alternative to a cash out refinance, a HELOC (Home Equity Line of Credit) and HELOAN (Home Equity Loan) offer some benefits over a cash out refinance. Most of the time, these loan products are used as a 2nd lien (meaning, your original mortgage remains, and this product is recorded against the title to the property separately), so if you have a really good first mortgage rate, you can leave it alone while accessing equity through a HELOC or HELOAN.

These products have gotten a lot more popular since rates have gotten more competitive on them. There are a wide variety of offerings, some with fixed rates and many with adjustable rates tied to the ‘prime rate’. Many HELOC products also come with an interest-only payment option, making them affordable on a monthly basis with very low minimum payments. HELOAN products have also become more affordable, with loan terms up to 30 years at attractive, fixed rates, especially for borrowers with a good amount of equity and great credit.

Like all refinance loans, it’s important to analyze the costs and work with a loan officer that can explain all of the program details so you fully understand the product and it’s pros and cons. Some of the features to ask about:

• Interest-only options?
• Loan terms (these loans tend to come with 5-30 year terms)
• Fixed VS Variable rate (tied to Prime rate?)
• Costs (closing costs AND annual fees – some HELOCs have a small annual fee)

The Big Picture

There’s no real rule around when the best time to refinance is – working with a great loan officer, you’ll have a professional constantly watching the market for ways to save you money. A skilled loan officer can also walk you through when doing a cash out refinance or HELOC/HELOAN, or NOT doing one, might make sense. It’s always a good idea to compare your monthly savings VS loan costs, and also consider the type of market you’re in when considering a loan (for example, in a market with rates falling, it makes sense to pay lower closing costs, and if the market’s close to reversing higher, it might make sense to pay extra for a reduced rate).

At Catalyst Mortgage, we’ve got the expert guidance you need to make the right decision when it comes to refinancing. If you’re wondering “when should I refinance?”, give us a call or reach out using our quick form and we’ll be happy to help provide you the answer you’re looking for!