New Paper Suggests Optimal Time to Refinance

According to results of a study recently released by a group of economists, the best time to refinance may be later, not sooner. Their research indicates that a new "one or two percent rule" may be valuable in predicting the most profitable time for refinancing a home loan.

Refinancing is often a smart option, because moving out of an expensive loan into a cheaper one can provide substantial savings, both in the near term as well as over the long haul. But economists at Harvard and Brown universities, working with the National Bureau of Economic Research, recently concluded a study that suggests that homeowners may want to exercise more patience before refinancing.

Refinancing can wait

Each time that you refinance, there are costs involved. These range from attorney's fees and appraisals, to lender's commissions and the price of shipping documents back and forth between the lender and the underwriter. While many of these expenses are tiny compared to the long-term savings that come with refinancing, they're still an important factor to consider. Some people refinance every chance they get, even though each time they incur those fees. This seems to be the crux of the specific problem revealed by the economic study, which indicates that as many as 30 percent of homeowners could save more money by refinancing less frequently. In other words, people are too eager to refinance every time rates drop because they're afraid of missing the chance before they go back up again. Then, if rates continue to drop, they refinance again. With rates steadily declining, and refinance fees constant, this can quickly undermine the overall goal of saving money.

The one or two percent rule

Results of the study cited above leads many financial advisors to the conclusion that a "one or two percent rule" is appropriate. Once rates drop one or two percent from the rate you now pay, you stand a much better chance of significant savings-even after the cost of the refinance is factored into the equation.

Some homeowners refinance to save a few dollars per month. Then, when rates drop again, they see another opportunity to save. But the new report suggests that it may be wiser to wait until the savings gained by the refinance are significantly large. That way, the costs of application fees, points, and other refinance expenses are minimized. If, for example, it would cost $1,500 to refinance and you'd save $50 a month, it would take 30 months to recoup your closing costs and break even. If you plan to sell your home within the next three years, you may not accomplish any gains whatsoever through refinancing. On the other hand, if you could save $200 per month at a cost of $1,500, it would take you only seven or eight months to break even and start realizing the savings. By waiting to refinance until the savings are greater, you drastically increase your savings over a shorter timeline.