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Refinancing: 2% rule of thumb

Author: Jessica Bennet
Community Mentor
Ask Jessica
Posted on: 10th Dec, 2005 03:38pm
Refinancing offers you the chance to lower down the rate of interest. Low rate of interest means that your monthly mortgage payment amount will be lower and you will be able to pay the loan with more ease. When you are seeking to get a low rate of interest, you need to follow the 2% thumb rule of refinancing.


The 2% refinance rule of thumb says that it pays to refinance if the rate of interest on refinancing loan is 2% lower than the rate of interest on your existing mortgage loan. Low rate on the new loan implies than you will be able to recover the costs of the new loan. In other words, you will be able to break even the costs of the new loan.


However, this 2% thumb rule of refinancing can’t be used universally. This rule may not be applicable in case of low-cost or no-cost mortgage refinancing loan. In case of a no cost mortgage refinancing loan though there are no upfront fees but all the costs are included in the mortgage rate of interest. So, obviously the rate of interest of a no cost mortgage refinancing loan is higher than the rate of a common mortgage refinancing loan. In other words, the rate of interest of a no cost mortgage refinancing loan is already high and so the 2% refinance rule of thumb may not be applicable here.

Posted on: 10th Dec, 2005 03:38 pm
I am about to refinance for the first time. In the process I heard the term 2% rule. What is it actually?
Hi Brenda,

2-percent rule is a thumb rule to determine whether it is going to be a good decision from financial side to refinance the mortgage.

As per this rule, if your rate on the mortgage is reduced by at least 2% then only you should refinance to get a benefit.

God bless you.

For MortgageFit,
Samantha
Posted on: 10th Dec, 2005 04:03 pm
Hi,

Experts suggest a 2-2-2 rule of thumb to determine whether or not refinancing would pay off. Refinancing would make sense if you have stayed in your house for 2 years, planning to stay there for another 2 years and the new rate is 2 points lower than your mortgage rates at present. This formula may not apply always because even a drop of 1% point from the present rate will make the refinancing attractive.

According to banking sources when the earning potential of your assets are more than the cost of financing, then you should consider a mortgage that minimizes your monthly payment. This way you can increase your cash flow for investing. It will be a mistake if you automatically refinance with your existing lender without considering other. So it is advisable that you discuss your alternative with a mortgage advisor.

Thanks,
Jerry
Posted on: 11th Dec, 2005 07:35 pm
I am refinancing at 1% point lower. Rates won't be 2% for me, unless some miracle happens! I am saving $150 a month on my mortgage. To me its worth it.
Posted on: 24th Nov, 2008 01:42 pm
Hi Guest!

Has the lender agreed to refinance the loan? Consult with the lender and check out whether you will face any issues later on or not.

Thanks
Posted on: 24th Nov, 2008 11:14 pm
The 2% rule was constantly discussed in 1985 whe I started in the mortgage business. Back then the maximum conforming loan was about $90,000. With mortgage amounts that low, the rate had to be 2% or more lower than the current rate to "break even on the costs" in 2 to 3 years. Now the maximum conforimg loan is $417,000. When mortgages are larger, it does not take a lesser rate of 2% to "break even on the costs".
In this day and age, I usually calculate how much the monthly payment needs to drop to break even in 2 to 3 years. On large loans, that could be a rate drop of .50%. Usually the break even point on costs is a drop in monthly payment of about $125. If your payment is dropping $150 a month, you are probably breaking even in 24 months or less. Today is Nov 25 and rates dropped dramatically today. You should be able to get a better rate today and break even faster than 24 months.
Posted on: 25th Nov, 2008 10:01 am
The easiest way to compare is to take the cost of refinancing (closing costs on a good faith estimate, not escrows and prepaids), then divide that by the amount of money you will save on your monthly payment. This will show you how long it will take to break even.

Example: If it costs you $3000 to refinance a loan that will save you $300 per month, you can break even after 10 months - smart! If it costs you $10,000 to refinance a loan that will save you $100 per month, it will take you 100 months to break even - not smart.
Posted on: 26th Nov, 2008 12:56 pm
Are you speaking about the benefits of the 2% rule or the 2% limited cashout available to you?
Posted on: 29th Nov, 2008 11:48 am
I have a 70000 mortgage at 5.375. I have seen an offer for 4.2% with 2 points up front. Is this worth refinancing?
Posted on: 27th Feb, 2009 04:42 pm
You should refinance only if you are planning to stay in the property for next couple of years. Otherwise, it wouldn't be reasonable to refinance the property. If you want to stay in the property, go ahead with the refinance option.
Posted on: 27th Feb, 2009 09:05 pm
dougie, you need to make a calculation to tell you how long it will take you to recoup the costs (2%) of your refinance. two points isn't a whole lot of money in comparison, but your savings on monthly payments will tell you a lot.
Posted on: 03rd Mar, 2009 11:16 am
I have a mortgage rate of 6.25% on a 204000 house for 30 years. Does it make sense to refinance to a 5.2% or a 4.75%? I am an elderly person and don't know how long I can stay in the house.
Posted on: 05th Aug, 2009 09:46 am
I have a mortgage rate of 6.25% on a 204000 house for 30 years. Does it make sense to refinance to a 5.2% or a 4.75%? I am an elderly person and don't know how long I can stay in the house.
Posted on: 05th Aug, 2009 09:47 am
2% rule is benefited for getting benefit of 2% while refinancing.
One should consult with lender
Posted on: 05th Aug, 2009 09:55 am
Exactly what Steve said. You loan can stay at the same interest rate, but you are paying off debt, then your saving monthly can quickly outweigh the cost of the loan.
Posted on: 05th Aug, 2009 10:47 am
but ashley, are you answering mamie? i don't think that's what she wants to know.

mamie - you mentioned you don't know how long you'll be in the home. if you're skeptical about making up the difference in costs by reducing your payments over time, then you might not want to bother with the refinance. you didn't mention any amount of closing costs, but you'd want to be certain that the savings you would reap in refinancing at the lower rate would compensate for the costs you would incur. if you can recover those costs in a 2-year period, for example, then it's usually worth it. if, on the other hand, you don't think you'll be there in 2 years, it's probably not worth the trouble.
Posted on: 05th Aug, 2009 11:58 am
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