Should I Refinance My Mortgage And When?
Mar 20, 2024
7-MINUTE READ
AUTHOR:
VICTORIA ARAJYour mortgage is likely to be one of the biggest and most important investments you make in your entire life – and it can also help you reach your financial goals. A mortgage refinance can be a wonderful tool to help you reach those goals even sooner.
But, should you refinance your mortgage? And when is it the right choice? You can make that decision confidently after understanding the circumstances that call for a refinance.
What Is A Mortgage Refinance?
A mortgage refinance is a transaction where you get a new mortgage to pay off your old mortgage. As a homeowner, you’ll have the opportunity to choose among all the types of mortgages available to home buyers. Understanding your options will help you choose the best loan for essentially buying your house for a second time.
Why Should You Refinance Your Mortgage?
Refinancing can allow you to change the conditions of your mortgage to secure a lower monthly payment, get a new loan repayment term, consolidate debt or even take some cash from your home’s equity to put toward bills or renovations.
Let’s delve deeper into the reasons to refinance your home.
1. You Want To Secure A Lower Interest Rate
It’s common for homeowners to refinance to take advantage of lower interest rates. If rates were particularly high when you took out your original mortgage and they’ve since dropped significantly, you’ll likely be able to refinance to a lower rate. This has the potential to lower your mortgage payment.
A lower mortgage rate doesn’t guarantee a lower monthly payment, however. Closing costs (if rolled into your refinanced loan), property taxes and insurance could all affect how much you’ll save each month – or if you save any money at all. Without factoring in taxes and insurance, let’s take a look at how a mortgage rate that’s 1% lower could impact your monthly payment.
| Loan Amount | Interest Rate | Mortgage Term | Monthly Payment | |
|---|---|---|---|---|
| Loan #1 | $250,000 | 6% | 30-year fixed-rate mortgage | $1,498.88 |
| Loan #2 | $250,000 | 5% | 30-year fixed-rate mortgage | $1,342.05 |
Based on this data from our mortgage calculator, you could save $156.83 a month by reducing your rate 1%. Consider these savings over 30 years, and you could save $56,458.80 in interest. While savings will vary based on a number of factors, the opportunity to save a significant amount of money is one of the most common reasons that homeowners refinance.
2. You Need To Change Your Loan Repayment Term
Homeowners might change their loan repayment term for multiple reasons. Here’s what you can expect with a longer loan term and a shorter loan term.
Longer Mortgage Term
Are you having trouble making monthly mortgage payments? A refinance can allow you to lengthen the term of your mortgage and lower your monthly payments. For example, you can refinance a 15-year mortgage to a 30-year loan to lengthen the term of your loan and make a lower payment each month.
When you lengthen your mortgage term, you may get a slightly higher mortgage interest rate. This is because lenders take inflation into account, and a longer mortgage term means you’ll likely pay more in interest over time. If you know your current payment schedule isn’t realistic for your household income, a refinance can free up more cash so you can invest, build an emergency fund or spend the money on other necessities.
Shorter Mortgage Term
You can also refinance your mortgage in the opposite direction, from a longer-term to a shorter-term mortgage. When you switch from a longer-term mortgage to a shorter-term one, you’ll likely enjoy lower interest rates and own 100% of your home sooner.Usually, switching to a shorter term also makes your monthly payments increase. Be sure you have enough stable income to cover your new payments before you sign up for a shorter term.
3. You Need Cash To Pay Off Debts
If you’ve made payments on your mortgage, you probably have equity in your home. Equity is the difference between your home’s fair market value and the amount you still owe to your lender. It’s possible to build equity in two ways: paying down your loan’s principal balance and the home experiencing an increase in value. Typically, if your loan is more than 5 years old, you’ve probably built a bit of equity in your investment just by making your regularly scheduled monthly payments.
Cash-Out Refinance For Debt
A cash-out refinance allows you to take advantage of the equity you have in your home by replacing your current loan with a higher-value loan and taking out a portion of the equity you have.
You might seek a cash-out refinance to pay off other debt. If you have higher-interest debts spread over multiple accounts, you can use a cash-out refinance to consolidate your debts to a lower interest rate, pay off each account and transition to one monthly payment. Consolidation can help you keep a better record of what you owe and reduce instances of missed payments, late fees and overdraft charges.
4. You Want To Make Home Improvements Or Renovate
From fixing a broken HVAC system to replacing the pink linoleum in the bathroom, you might need to refinance to invest in home improvements at some point or another. Using home equity can be better than taking out a personal loan or putting charges on a credit card because cash-out refinances usually have a lower interest rate than both.
Cash-Out Refinance For Renovations
Though you can do virtually anything you want with the money from a cash-out refinance, it’s important to remember your refinance is still a loan. It’s a good idea to get estimates from contractors or repair professionals before you close on your refinance. This will lessen the chance you take out too much money or take out too little and have another bill after the job is finished.
5. You Want To Allocate More To Retirement Savings
One of the most powerful tools you can take advantage of when saving for retirement is compounding interest. The earlier you start to invest and save, the more years you have to accumulate interest on your investments before you retire.
Cash-Out Refinance For Investing
If you have equity sitting in your home but you haven’t maxed out your annual retirement contribution limits, you may end up making more money over time by taking a cash-out refinance and investing the difference.
You can also use the money from a cash-out refinance to invest in your property. Whether you want to add a new bathroom, spruce up your paint or install a privacy fence, you’re only limited by your imagination. Upgrades can bring in more money when you want to sell your house by increasing your home’s value and curb appeal, both of which can help you secure a higher final closing price.
6. You Want To Convert An ARM To A Fixed-Rate Mortgage
An adjustable-rate mortgage (ARM) generally offers borrowers a lower interest rate at the beginning of the loan. But, after a fixed period (usually 5, 7 or 10 years), the interest rate has the potential to fluctuate – and not always in the borrower’s favor. For this reason, some homeowners will opt to refinance their ARM to a fixed-rate mortgage, which eliminates this fluctuation in interest rate.
It’s also possible to refinance a fixed-rate mortgage to an ARM. This involves some risk, but it could be a smart option if interest rates are falling. Or, it may be wise if you plan to sell your home before the initial period of fixed (generally lower) interest ends.
How Do You Decide If You Should Refinance?
It’s important to take a holistic approach in determining if a mortgage refinance is a good option for you.
Understand Mortgage Refinancing
Next, take the time to thoroughly understand what a mortgage refinance is and how it works. This will help ensure you don’t encounter surprises along the way.
Refinancing comes with pros and cons. A drawback of refinancing is that it incurs closing costs. Make sure you take expenses and other potential downsides into account when deciding whether a refi is right for you, particularly if you’re planning to sell in the near future.
Consider Your Short- And Long-Term Goals
Your short- and long-term goals are important in deciding whether refinancing is a good idea. First, you’ll want to look at your current finances. Assess your long- and short-term financial goals.
Do you plan to sell your home or make any other large investments in the next 5 – 10 years? These, among other factors, will impact whether the cost to refinance your mortgage is worth it.
Use A Mortgage Refinance Calculator
To get a basic idea of how a refinance could affect your monthly mortgage payment, it’s best to use a refinance calculator. Simply input some basic information about your goals, current mortgage, where you’re located and your credit score, and you’ll instantly be able to calculate what your refinance payment could look like.
Calculate Your Break-Even Point
Your refinance break-even point is a calculation that helps you identify whether it makes financial sense to refinance. After using a refinance calculator to see how much you’ll save on your mortgage payments each month, you can calculate your break-even point.
Let’s say you save $200 a month by refinancing and your closing costs are $18,000. Divide your closing costs by your monthly savings ($18,000 divided by $200), and you’ll see it should take 90 months – or 7.5 years – to break even.
This may seem like a long time, but if you’re planning to stay in the home longer than 7.5 years, you’ll end up saving money. If you don’t intend to stay this long, however, it probably wouldn’t be wise to refinance. That’s because you’ll end up spending more money on refinancing than you save.
When Should You Refinance Your Mortgage?
Think you’re ready to refinance? Timing is a huge consideration. Make sure you meet the requirements to refinance first. And, don’t forget to consider home values and interest rates in your area, how long it can take to refinance and how often you can refinance.
Next, we’ll look at some other circumstances under which it might be the right time to refinance.
When Your Credit Score Increases
Waiting for interest rates to drop isn’t the only way to qualify for a lower rate. You may also qualify if your credit score is now higher than it was when you applied for a loan. Lenders look at your credit score before offering you an interest rate because they need to know how reliable you are as a borrower. If you have a higher score, you’re statistically less likely to miss a payment or fall into foreclosure. As a result, your lender takes less of a risk when they loan you money and can give you a lower interest rate.
When Interest Rates Are Low
One of the best times to reevaluate your mortgage is when interest rates on home loans significantly drop. Your interest rate plays a large role in the amount of money you end up paying for your home. If you locked into a loan during a time when rates were high, you might be overpaying for your mortgage. You can save money by refinancing to a loan with a lower rate.
FAQs: Should I Refinance My Home?
Now let’s walk through the answers to some frequently asked questions about whether you should refinance and when to refinance a house for the best use of your money.
Is it a good idea to refinance my house?
It might be a good idea to refinance your home loan if you’re interested in saving some money, have a higher credit score and you’re able to obtain a lower interest rate. This financial decision should be made with careful consideration.
When shouldn’t I refinance my mortgage?
If you calculate your break-even point and it would take you longer to break even than you plan on keeping the mortgage, it’s likely not worth it to refinance. Having a poor credit score or being unable to cover closing costs are other reasons you shouldn’t refinance.
What are the risks with refinancing my mortgage loan?
As with any loan option, refinancing has some disadvantages to be aware of. One of the main disadvantages of a refinance is that it incurs closing costs, which can get expensive. Be sure to weigh all of the fees involved with refinancing before deciding if it’s right for you.
How much does it typically cost to refinance?
When you refinance, you must pay closing costs, which are typically 2% – 6% of your loan amount. So, if you take out a loan for $250,000, you can expect to pay about $5,000 – $15,000. The bigger the loan, the higher your closing costs.
Is now a good time to refinance?
Take a look at current mortgage rates to decide if now is a good time to refinance. If rates are lower than when you took out your original mortgage, it may be a good time for you to refinance.
But, your personal situation, along with the conditions of the new loan, will ultimately determine if now is the right time to refinance. Speak with a lender that can help you run the numbers and walk you through the decision.
The Bottom Line: Use A Refinance Calculator And Loan Experts To Decide When To Refinance Your Home Loan
Everyone’s situation is different, but a refinance can be a worthwhile financial endeavor for some homeowners. Before moving forward, though, take the time to find the right mortgage refinancing option for your specific situation – if you’ve determined that a refinance is, in fact, the way to go.
Lean on your lender’s expertise and online calculator tools to get on the right path.
If you’re ready, get started on the refinance process today with Rocket Mortgage®.
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