Mortgage interest rates have been declining recently, and you may be wondering whether it makes sense to refinance. If you can either lower your monthly payment, or keep your payment about the same but pay your loan off faster, then it might. Since there is no one defining way to determine whether the time is right for you, here are a few things to consider:
- Interest Rate: A lower interest rate is certainly a good thing when it comes to refinancing. But just how much lower does the rate need to be? The short answer is, it depends on the individual situation. A ½ percent drop in could make sense for someone that has a larger loan amount, but not for someone else with a smaller loan balance.
- Mortgage Insurance: If you took out your loan a couple of years ago and have mortgage insurance on it, a small drop in interest rate could translate to a significant reduction in your monthly payment. Often in refinancing, the lender will require a new appraisal. If your home’s value has increased to where you now have 20% equity, not only will you save money with the lower interest rate, but no longer having to pay mortgage insurance can really increase your savings.
- Other Debt: Have you taken out a home equity loan or maybe incurred some credit card debt? Refinancing your home mortgage will save you money on the mortgage loan. If you can also roll in other debt with higher interest, the benefit of refinancing increases.
- Future Expenses: When rates drop and you are considering a refinance, you should first think ahead about expenses on the horizon for which you may be falling short in saving. Do you have kids going to college? A wedding on the horizon? Home improvement projects? These are things that we often wait to pay for until the need is immediate, and for which we end up paying a higher interest rate.
- Your Mortgage Type: You may have taken out an adjustable rate mortgage (ARM) loan a few years ago, because the interest rate was lower than the fixed rates. Or maybe you didn't think that you'd end up holding on to your home for as long as you have and now plan to, because your circumstances have changed. In instances such as these, converting your ARM to a fixed-rate mortgage might be your best option, as fixed rates are often lower than ARM rates.
- Your Mortgage Term: When you originally took out your mortgage, you may have gone with a 30-year fixed option, to keep your payment as low as possible. Now, a few years later, your income has increased, and lower interest rates may mean you can not only reduce the interest you are paying, but also reduce the term. If you were to refinance to a 20- or 15-year term loan, your monthly payment might not really go down, but your overall savings on the loan definitely will.
No matter your situation, if you are considering a refinance, you need to also consider what the costs are and where the break-even point is. If you are to be saving $100 a month and it’s going to cost $1500 to refinance, then your break-even point is 15 months. You will need to have your mortgage for at least 15 months for it to have made sense to pay the fees to save the $100 a month. Determining your break-even point is straightforward when your monthly payment is going down. If you are refinancing and your payment is staying the same (e.g., if you're shortening the term), then you need to compare what you would have paid in interest and payments on your current loan with the total cost of the new loan.
Once you have made the decision to refinance, you will still need to fill out the same paper work you did when you initially applied for your loan. Although you already have a mortgage – and refinancing will only put you in a better position financially – your lender still has to underwrite your loan as they do every other one that comes across their desk, so be prepared to provide up-to-date financial information such as pay stubs, W-2s, and bank statements.
To find out whether a refinance may be in your best interests, please send me an email and let's find a time to connect.