Is refinancing my mortgage a good idea?

The typical rule of thumb is that if you can reduce your current interest rate by 0.75% to 1% or higher, then it might make sense to consider a refinancing move. The first step is to calculate your monthly savings should you do the refinance.

For example, suppose you have a 30-year mortgage loan for $200,000. When you took it out, you got a 6.5% interest rate (fixed), and your beginning of month payment is $1,257. If interest rates now are at 5.5% interest (fixed), this could reduce your monthly payment down to $1,130. This would be a monthly savings of $127, or $1,524 annually.

Next, you'll need to ask your new lender to calculate your total closing costs for the refinance if you were to proceed. If your costs come to approximately $2,300, you know that your break even point would be 1.5 years in the home ($2,300 divided by $1,524 = 1.5 years).

In this scenario, if you plan on staying in the home for two years or longer, refinancing makes sense.

Keep in mind that during periods when home values decline, many homes get appraised for much less than they were historically. This may cause you to not have enough equity in your home to satisfy the 20% down payment on the new mortgage, and may require you to come up with a larger cash deposit than expected. Or you may have to carry private mortgage insurance, which will ultimately increase your monthly payment. So in these instances, even with the drop in interest rates, your real savings may not amount to much.

(For more, see "6 Questions to Ask Before You Refinance" and "Mortgages: The ABCs of Refinancing.")