When mortgage rates begin falling, more and more homeowners decide to refinance their loans. Depending on a person’s individual situation, however, it isn’t always the best move. Here’s what you should know about refinancing, along with tips for deciding whether it’s right for you.
Why Do People Refinance their Loans?
There are several different ways to refinance a mortgage, and finding the right loan will depend on your financial goals. You might want to switch from your adjustable-rate mortgage to a standard fixed-rate loan with a steady monthly payment. On the other hand, you may want to shorten the term of your mortgage loan from a 30-year plan to a 15-year agreement to avoid interest charges. A refi can also allow you to escape the high costs of private mortgage insurance once you accrue 20% equity in your home.
The majority of homeowners seek straight rate-and-term refinancing that lowers their interest rates while providing a comfortable repayment term. Some are looking for lower monthly payments to free up cash for college tuition, auto loans or other expenses. Others want cash-out refinancing, in which they borrow more than they owe and use the cash to pay for home renovations, eliminate credit card debt or fund some other major expense.
When is a Good Time to Refinance?
Most people start thinking about refinancing their mortgage loans when they learn that mortgage rates are on the decline. While lower mortgage rates are definitely a key factor in determining whether you should refinance, there are other good reasons including:
- You want to pay off your home loan quicker with a shorter term.
- You’ve accumulated enough equity in your property to refinance into a loan that doesn’t have mortgage insurance.
- You are looking to tap some of your equity with a cash-out refinance.
In general, it’s a good idea to refinance if it will help you build equity, allow you to save money or pay off your mortgage faster. It’s best to consider refinancing if you will be able to lower your interest rate by about one-half to three-quarters of one percentage point since this can significantly lower your monthly payment.
Things to Consider
To gain noticeable benefits from refi, you need to make sure your total monthly savings will offset the overall cost of refinancing. It may not be a good idea to refinance your existing loan if you plan to move in the next 24 months since you won’t have a lot of time to recoup the cost.
While interest rates are a primary consideration when it comes to refinancing; it’s important to remember that they aren’t the only key factor. To qualify for the right refinance loan, you will need to have good credit. Mortgage interest rates are influenced by various market factors, including the current yields on long-term Treasury bonds, and the lowest rates and best terms will always go to borrowers with the best credit scores.
Is it Worth the Costs?
Anytime you refinance a home loan, you will typically spend an average of between 2% and 5% of the entire loan amount in closing costs. With this in mind, it’s very important to figure out how long it will take for your monthly savings to recoup those high costs. In mortgage refinance, this is often referred to as the “break-even point.” For example, it would take 40 months to break even on $4,000 in closing costs if your monthly mortgage payment were to drop by $100. If you decide to move during those 40 months, you will ultimately lose money in a refinance.
When deciding whether to refinance, don’t just think about current mortgage rates; think about whether your current home will continue to fit your lifestyle in the future. If you’re thinking of starting a family or headed toward an empty nest, there’s a chance you won’t stay in your home long enough to break even after refinancing.
Even if your new loan will lower your rate considerably, you should consider whether it’s worth taking on the added interest. If you’re already more than ten years into your loan, refinancing to a new 20- to 30-year loan will tack on interest costs since interest payments are front-loaded. The longer you pay on a mortgage, the more you pay toward the principal instead of interest.
Before going ahead with refinancing, ask your lender to run the numbers on a loan term that’s equal to the number of years you have remaining on your existing mortgage. You might end up lowering your payment, reducing your mortgage rate and saving on interest by deciding not to extend your loan term.