This article covers mortgage refinancing and how to know when it makes sense to refinance.
People are often on the fence as to whether they should refinance their mortgage. Many experts out there have “rules of thumb” to answer the question, “Should I refinance?” For instance, some say you should refinance if interest rates drop by .5%, or 1%, or whatever. But the decision to refinance or not actually depends on whether refinancing will help you achieve your goal.
When Should I Refinance My Mortgage?
Mortgage refinances cost money in up-front fees. You shouldn’t refinance the mortgage just because rates have dropped by half a point. Homeowners need to evaluate the net tangible benefit by refinancing.
There are several common reasons that homeowners refinance:
- Pay less interest over the life of the loan
- Lower the monthly payment
- Cash out some home equity
You can pay less interest by refinancing to a lower interest rate, a shorter term, or both. Refinancing can reduce your monthly cost by extending your repayment over a longer term, by lowering your interest rate, or both. And you can convert your home equity to cash with a home equity loan or cash-out refinance.
It makes sense to refinance if you can accomplish your goal by doing so.
Understanding Refinance Breakeven
If your main goal for refinancing is to lower your interest expense, you’ll want to make sure that you will break even before you sell your home. You want to make sure that you’ll recoup the cost of refinancing during the time that you expect to own your home.
For instance, if your new loan saves you $250 each month and refinancing costs $5,000, you’ll break even in 20 months. If you expect to own your home for five years (60 months), you’ll end up ahead by $10,000 by refinancing. But if your savings were only $75 per month, it would take 67 months to break even, and refinancing wouldn’t make sense.
A good refinance breakeven calculator makes it easy to determine your potential savings from refinancing.
Refinancing to Lower Your Mortgage Rate
You could drive yourself crazy monitoring interest rates on the financial pages. They change all day long. But interest rates throughout the country don’t really determine your refinance decision. There are many reasons that you could improve your mortgage even if interest rates overall are higher.
Your credit rating might have improved recently. If your FICO score increases even by 20 points, that could qualify you for a lower mortgage rate than the one you have. Check with a lender to see where you stand.
If your finances have improved, or your mortgage is over ten years old, consider refinancing your home from a 30-year to 15-year mortgage. Interest rates for 15-year loans run .5% to 1% lower than rates for 30-year loans. So you could get a lower rate, a faster payoff, and pay less interest over the life of your loan.
If your home value has increased and you’re currently paying private mortgage insurance (PMI) or government-backed insurance (MIP), you might be able to refinance to a loan with no mortgage insurance. Or at least cheaper mortgage insurance. Even if mortgage rates have not dropped for everyone, you could save by refinancing to a loan with no PMI or MIP.
However, there is no need to refinance your home if you’ve paid down your loan to 80% of the sales price. Instead, contact your lender to eliminate the mortgage insurance premiums you’re paying if they haven’t already canceled it. Note that this applies to conventional (non-government) loans only. The only way to cancel monthly MIP for FHA and USDA loans is to refinance to a conventional loan.
Refinancing for a Lower Payment
If you’re refinancing to reduce your payment, there are a few ways to do that. First, you can reduce your payment just by taking your remaining balance and refinancing it to a new term. Even if your interest rate was the same, your payment would be lower (try it with a mortgage calculator and see for yourself).
If you can get a new term plus a lower interest rate, you can drop your payment even more. And features like interest-only payments can give you still more breathing room. Understand that extending your term to get lower monthly payments will probably increase your cost over the life of the loan.
Refinancing for a Stable Payment
Finally, some homeowners refinance to replace an adjustable-rate mortgage (ARM) with a fixed-rate mortgage. With fixed mortgage rates under 3% for 15-year loans and 4% for 30-year loans, it makes little sense to choose an AR today. And it makes a lot of sense to nail down a low fixed rate if you plan to keep your home and your mortgage for more than a few years.
Refinancing for Cash Out
You can refinance your mortgage to take cash out of your home, whether you need to pay off other high-interest debts or fund a home renovation. Refinancing for debt consolidation should not be done lightly, especially if your debts are the result of overspending. If you don’t stop overspending, you’re likely to run up your credit cards again and find yourself in a worse financial position overall. (85% of people who consolidate debt run their credit cards back up.)
There are other questionable uses for cash out. Don’t add to your mortgage debt to buy a car or go on vacation. Financial experts recommend that you use short-term financing like auto or personal loans to buy short-term assets like cars. You don’t want to be paying for 30 years on a car you junked a decade ago.
Be very careful about borrowing money to renovate your home. However, this could be reasonable if you need to fix the roof and replace floors after a flood for instance. If you’re upgrading a property so you can age in place or expand it, contact a reputable real estate agent instead to see if you would be better off moving.
When Should I Refinance My Mortgage?
If you’re still wondering, “When should I refinance my mortgage? ” click the link below to get a custom refinance quote from Gustan Cho Associates. Plug that interest rate and mortgage costs into a refinance breakeven calculator and find your breakeven point. As long as you own your home longer than the breakeven point, you’ll come out ahead by refinancing.
The “No Brainer” Refinance
What if you don’t know when you’ll sell your home? In general, it makes sense to refinance with the least amount of upfront costs if you don’t know how long you’ll have your loan. And if you can pull off a no-cost refinance and still have a lower interest rate, your breakeven point is zero and you’ll always come out on top.
What’s a “no-cost” refinance? It’s a refinance in which the lender pays all of your closing costs for you, and in exchange for this, you pay a slightly higher interest rate. If that rate is still lower than your current loan’s interest rate, refinancing makes sense for you.