When do you consider refinancing?

Question

We rented our first property 2 years ago and financed it at 7.25% with the idea when rates came down we would refinance. At what rate would you consider it worth it to refinance?

Patrick Roberts · Answer

It will depend on your loan size and the recovery period. Typically, if you can recover the cost of a refi in under 2 years, it's worth considering, and if under 1 year, then it's probably a good idea. A % reduction in rate doesnt always tell the full story because a 1% reduction on a loan balance of $100k wont save much, but a half percent on $600k will save a fair amount.

Jeff S. · Answer

I suggest a different method, @Christina Swaby.  Instead of a rule-of-thumb, payback period, or arbitrary “Do it when your rate drops X%,” consider a more analytical approach using your Return on Equity.

ROE = Annual Net Income after expenses (including mortgage) ÷ Equity

In many areas, where equity grows faster than you can increase rents or minimize expenses, your ROE will drop over time. Normally, as properties appreciate and mortgages are paid down, equity naturally builds, and at some point, your ROE will be lower than the return you could achieve in another investment. Prudent financial planning suggests setting a threshold ROE as a goal.

When your ROE drops below your threshold, it signals the time to extract “trapped” equity and place it into another investment with a higher return. Of course, this assumes another investment is available, along with a few other considerations.

For example, if your ROE is low but reasonable, it would make no sense to refinance and put the funds in a savings account at 1%, even if interest rates have dropped by the rates noted above. On the other hand, lightning does strike occasionally, and a great deal with a high return could fall in your lap. Here, it could make sense to refinance even at a relatively high rate to take advantage of the opportunity. Real life will fall in between these examples, but you get the idea. Another consideration is to avoid overleveraging yourself and risking your positive cash flow.

I think a benchmark Return on Equity is a better way to make your decision, Christina, than simply looking at interest rates or breakeven periods.  ROE is much more encompassing and an important measure of efficiency that you can use to decide when to refinance.  You can also use it to help decide when to sell—but that’s another topic.

Nick Belsky · Answer

@Christina Swaby

That is truly relative to each loan situation.  Generally speaking, the cost to refinance will usually take between 2-4 years to recoup the cost via lower interest savings.  With that said, the loan size plays a large role here.  Typically, we don't see a worthwhile gain for most loans unless you can reduce the interest rate by between 1.5-2.0%.   There are exceptions to this, of course, but generally, that is where most loan can make sense to refi.

Cheers!

Timothy Devitt · Answer

It will always depend on exit strategy,

if the goal is to cash out and roll into the next property, there’s often no better time to scale — even if rates aren’t ideal. It really comes down to how the refinance supports your overall investment plan.

Let's connect.

Andrew Zamboroski · Answer

Whenever there is a tangible benefit to you. In sum, whenever the benefits outweigh the costs of the new mortgage. This could be for a reduced rate/payment, cashout, etc.

Mike Grudzien · Answer

I concur with the above.  1% at least, and then run the numbers against your long term goal.

Joyce Ann Magallanes · Answer

@Patrick Roberts

You’re absolutely right—you can always do a rate and term refinance without buying down the rate. I should have clarified my earlier point better. I was referring to the specific scenario in the original post: with their current rate of 7.25% and where market rates stand today, a standard rate and term refinance might not provide significant savings after factoring in closing costs, unless it's a full-doc loan where rates tend to be more competitive. Thanks for pointing that out!

Erik Estrada · Answer

You should consider that each time you refinance, you will pay closing costs and will hit the reset button on the amortization schedule on the loan. If your goal is to pay down the loan quicker, making extra principal payments will certainly help more long term.

If your goal is to cash out, and increase rental income, then you should consider at least a 1% rate reduction before pulling the trigger, unless you absolutely find a deal you need to close on.

Deborah Wodell · Answer

Hi Christina!

Refinancing is usually worth it if you can drop your rate by at least 1%, especially if you plan to keep the property long-term. At 7.25%, it could make sense once rates get closer to 6% or below, depending on your equity and goals.

Joyce Ann Magallanes · Answer

Hello Christina!

Just to clarify, refinancing typically wouldn't be an option unless it’s a cash-out refinance or you're looking to buy down the rate. Are you considering a non-QM lender that doesn’t require job income to qualify?

When do you consider refinancing?

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