September 29, 2020
4 MINUTE READ
If you are a homeowner, you might be wondering if you should refinance your mortgage. Refinancing a mortgage means paying off the old home loan and taking out a new one with different terms. Those terms include things like the interest rate, whether the interest rate is fixed or adjustable and the number of years left on the current mortgage.
Along with changing the terms of the mortgage, refinancing also gives homeowners the chance to tap into what is likely your biggest piggy bank, the equity in their home – potentially at a lower interest rate than that of a home equity loan.
Refinancing is a big step that has the potential to save you money. But you want to make sure you are refinancing for the right reasons and that the numbers make sense or else you could end up costing yourself more money than it’s worth.
Mortgage professionals say that refinancing costs anywhere from 3 percent to 6 percent of the principal amount of the loan. That means it can take a number of years to recover that cost and realize any savings. There are several factors to determine if it’s worth it to refinance your mortgage.
1. Switching Between An Adjustable-Rate And Fixed-Rate Mortgage
Adjustable-Rate Mortgages often entice homebuyers with a low initial rate. However, many people think a fixed-rate mortgage looks better when the rate starts going up on an ARM. That is particularly true when the interest rate on fixed-rate mortgages is low.
Conversely, an ARM can look like the sensible way to go at a time when interest rates are falling. That is because just as rising interest rates cause the rate on an ARM to adjust upward, an ARM rate will adjust downward when interest rates fall, and that means the mortgage payment amount goes down. Mortgage professionals say that someone who only plans to stay in their home for a few years is probably better off with an ARM.
2. Lower Interest Rates
When interest rates are low, people can often save a good bit of money by refinancing, even after paying closing costs and other fees. For example, going from 6.10 percent to 5.25 percent with a 30-year loan on a $331,500 mortgage can drop the payment from $2,156.17 to $1,830.56 per month. The thought of having an extra $325.61 in the pocket every month is appealing.
However, if you only plan to stay in your home for a few more years, you might not come out ahead. Since most people are not math geniuses, it can be tricky to figure out whether you will come out ahead or not by refinancing at a bargain interest rate. Instead of dusting off your old math textbooks, use our convenient online refinance calculator to discover if refinancing saves money or costs in the long run.
3. Shorter Mortgage Length
Some people are tempted to refinance a 30-year mortgage to a 15-year mortgage to pay the mortgage off quicker and save money on interest. However, loan professionals say you can accomplish the same thing by doubling up on mortgage payments without the expense of paying closing costs and other fees to refinance. This approach also gives you the flexibility to back down to your original payment amount in case you run into financial problems in the future. Your lender will allow you to accelerate your payments as long as your mortgage does not have a prepayment penalty clause.
It’s still may be a good idea to refinance to a shorter length if you can decrease your payment or keep it the same. This means you’ll be saving money on either your payment or interest expense over the term of the loan. If you choose a shorter loan period such as a 15 year option you’ll get a significantly lower interest rate versus a 20 or 30-year loan.
4. Tapping Your Home Equity Piggy Bank
If you have significant home equity, there are many temptations to refinance at a low-interest rate and tap into that piggy bank. Among those temptations is a desire to consolidate high-interest credit card debt, to fund extensive redecorating or remodeling, or the desire to fund a child’s college education. You want to make sure that tapping into your home equity makes sense before pulling the trigger. You don’t want your loan to value ratio to be higher than 80% because that triggers private mortgage insurance (PMI) that would be expensive.
It’s all about the Benjamins…
Refinancing to save money by switching between an ARM and a fixed-rate interest mortgage makes sense, as does refinancing to save money by taking advantage of a lower interest rate. It all comes down to the numbers. Run a few quick calculations to determine your break-even point to see how long it will take you to recoup any closing costs. Use our free mortgage refinance calculator to calculate your break-even point and to see if you should refinance.