Is refinancing above 4 percent still worth it?

Tony Moton
Don't let rising interest rates fool you - you could still see some big savings if you refinance to an interest rate around 4 percent.

News of rising interest rates has been sounding off alarm bells during the first half of 2013, but industry experts say homeowners who refinance a home loan in the 4 percent range could still see some significant savings.

In fact, according to Freddie Mac's 2013 First Quarter Refinance Report, homeowners who refinanced in Q1 of 2013 reduced their mortgage by an average 1.9 percent - which translated into a savings of about 35 percent off the homeowners' monthly mortgage payment. And while we know that interest rates were lower in Q1 than they are now, homeowners can still take advantage of seeing some savings by refinancing.

"If you can get a 4 percent rate on a 30-year fixed (loan), that's great. It's still lower than any interest rate you might get on a credit card, car loan, or any other type of loan, "says Lisa Miller, a loan officer with the San Diego-based Integrity Mortgage Group.

Still wondering whether you should refinance now? Here are some things to consider before you make your decision…

Is Your Current Interest Rate 5 Percent or Higher?

If you have a 30-year fixed-rate mortgage and your interest rate is in the 5 percent or higher range, you should think about the savings you could see from refinancing to a lower rate.

But how many percentage points are enough to justify a refinance?

"One percent is usually a good reason to refinance for most people," says Cathy Conrad, a colleague of Miller's at the Integrity Mortgage Group. And the "good reason" Conrad is referring to is the amount of savings a homeowner can achieve.

To give you an idea of how much you can save by dropping your interest rate by one percent or more, we'll use an example. 

Let's say you took out a $300,000 mortgage at 6 percent in 2007. In the past five years, you've managed to pay your mortgage down by $30,000. Based on the numbers below, refinancing the remaining $270,000 to a 25-year fixed-rate loan with a rate of 4.5 percent could yield some big savings:

  4.5 percent 6 percent
Loan Amount $270,000 $300,000
Length of Loan 25 years 30 years
Monthly Payment $1,500.75 $1,798.65
Total Interest Paid $180,224.31 $347,514.57

[Ready to save some money and refinance your mortgage? Click to compare interest rates from lenders now.]

Can You Afford the Closing Costs?

When refinancing, savings isn't the only factor to consider, says Conrad.

"[A homeowner has] to look at the costs [of refinancing], how much they are going to save monthly, and how long it's going to take to break even," he says.  

Conrad is referring to closing costs, which can run anywhere from 3 to 6 percent of the mortgage amount that you are refinancing, according to the Federal Reserve. So you need to consider how long it
will take to recoup the closing costs through the savings you'll see by refinancing.

If you don't have the cash on hand to cover the closing costs, a good option to consider is obtaining a "no-cost loan." According to the U.S. Department of Housing and Urban Development (HUD), this type of loan comes with zero closing costs.

"This lessens the need for upfront cash during the buying process; however no cost loans have a higher interest rate," Conrad says. "The interest rate is higher, but [the borrowers] will get a credit back from the lender to cover the non-recurring closing costs," Conrad says. That way, you can start saving each month without having to cough up the cash up front.

Will Refinancing Eliminate Private Mortgage Insurance (PMI)?

If you're paying private mortgage insurance (PMI) and the price of your home has risen recently, you could see some big savings by refinancing, even if the rate is above 4 percent.

That's because most lenders require you to pay PMI if you have less than 20 percent equity in your home. However, if you're still below 20 percent equity, refinancing could help you eliminate your PMI.

Here's an explanation from National Association of Realtors on how it works:

"When you approach a new lender to refinance, they will have the house appraised. This is to make sure that your home has not decreased in value. If the house has increased in value enough and the new loan given can account for less than 80 percent of the house value, then you will not have to pay PMI."

And since PMI can typically equal .5 to 1 percent of the amount you still owe on the loan per year, it can be a hefty expense to knock off. For example, if you still owe $250,000, 0.5 percent divided by 12 months equals $104 per month for PMI alone.

[Ready to lock-in a lower interest rate? Click to compare mortgage rates from lenders now.]

Is it a Risk to Wait for Rates to Dip Below 4 Percent Again?

Both Conrad and Miller say homeowners have every right to be cautious when it comes to trying to get a better interest rate. But with that said, waiting for them to dip below the 4 percent mark again could turn out to be a missed opportunity.

"People really need to ask questions," Conrad says. "Some people think their property taxes will go up if they refinance, and that's not true. How much they earn and how good their credit is are two of the main reasons that can determine how likely they are going to benefit from a refinance."

So if you stall on putting your refinancing plan into action, you might miss out on potential savings, Miller says.

"If you are at 5 percent and can get down to 4 percent, you should do it right away," Miller says.

Adds Conrad: "You just have to go through the numbers, but if you can save money now, you might want to refinance now because the rates might go back up."