Story summary: Freddie Mac’s chief economist recently predicted a gradual rise in mortgage rates through the end of 2013. This will likely create a sense of urgency among homeowners planning to refinance. It also begs the question: “When should I refinance my mortgage?”

For many homeowners, 2013 will be a good time for refinancing. Thirty-year mortgage rates are still low, and they are expected to remain below 4% for at least the first half of 2013.

At the same time, home prices are rising in many parts of the country. The latest release of the S&P/Case-Shiller index showed that U.S. home prices rose 7.3% in 2012. This puts more homeowners in a position to refinance their homes.

But those record-low rates may not last. According to the latest forecast from Freddie Mac, the average rate for a 30-year home loan could rise to 4% by the end of this year. Here’s a snapshot of their latest projection tables, revised on February 13, 2013:

Low rates alone are not enough to justify a refi. When deciding when to refinance your mortgage, you must first calculate your break-even point to determine when the savings will come.

5 Most Common Reasons for Refinancing a Home

When deciding when you should refinance, you must first consider your primary reason for refinancing. Chances are, you are doing it for one of these five reasons:

  • To lower the interest rate and monthly payments associated with your mortgage.
  • To reduce the term (or length) of the loan, in order to pay less interest over time.
  • To switch from an adjustable / ARM loan to a fixed-rate mortgage.
  • To consolidate and pay off other debts by using the equity in your home.
  • To tap your equity for some other purpose, such as a remodeling project or a child’s college tuition.

You can even combine two or more of the items on this list. For instance, you might be able to refinance into a lower interest rate while also switching from an adjustable to a fixed mortgage loan.

In this article, we will focus on reason number #1 — lowering your monthly payments. That’s the most common reason for refinancing a mortgage. (We will examine the other strategies on this list in subsequent tutorials.)

How to Decide When to Refinance

So now we are one step closer to answering the question: When should I refinance my mortgage loan? If you are refinancing in order to lower your payments and save money over time, you must do the math to determine your break-even point. You would do this by comparing your upfront costs with your long-term savings.

At a minimum, you need to answer three questions:

  1. How much will you be able to lower your monthly payments after refinancing?
  2. How long do you plan to stay in the home and keep the new mortgage?
  3. How much will you pay in closing costs when you refinance into the new loan?

Based on these three items, you should be able to calculate your break-even point. This is the point at which your accumulated monthly savings (resulting from the lower interest rate and payments) begin to exceed the amount paid in upfront closing costs. In most cases, this is how you would decide when to refinance a mortgage loan.

When Will You Break Even?

Lowering your monthly payments is not enough. Some homeowners believe that refinancing makes sense as long as they can secure a lower interest rate on the new loan, thereby reducing the size of their monthly payments. But by itself, this is not sufficient reason to refinance a home. You must do the math to ensure that your monthly savings will eventually surpass the amount you’ll pay in closing costs. This is the key to deciding when you should refinance the mortgage.

And speaking of math, here’s a handy little worksheet you can use to determine your break-even point and your potential savings. (Click here for the printable PDF version.)

Here are the steps to take, as shown in the image above:

  1. Enter the amount of your current monthly mortgage payment.
  2. Enter the amount of your new (and lower) monthly payment, after refinancing.
  3. Subtract the lower payment from the larger one. This will be your monthly savings after refinancing.
  4. Identify the total costs of refinancing your home.
  5. Divide your closing costs by the monthly savings. This tells you how many months it will take to recoup the costs of refinancing.

Example: If you complete this process and come up with 36 as your final number, you’ve identified your break-even point as being 36 months. This is the point at which your monthly savings will begin to exceed the amount paid at closing. So if you keep the loan for more than three years, you will begin to see real savings. The longer you keep the loan beyond the three-year point, the more money you will save. On the other hand, if you sell the home before reaching the three-year breakeven point, you have lost money on the deal.

Disclaimer: This article answers the question, When should I refinance my mortgage loan? This lesson assumes that you are refinancing solely for the purpose of lowering your monthly payment and saving money. This is only a basic overview of the steps involved. We encourage you to do all of the necessary math before refinancing, to make sure it will work out your financial advantage. Your lender should be able to provide all of the numbers needed for the worksheet above. This will give you a general sense of where your break-even point lies.