If you’re a homeowner, you may have noticed that mortgage rates have been on the decline recently and that probably means you’ve been hearing about how it’s a prime time to refinance.
People refinance for all sorts of reasons:
- Lower interest rates, which can help you save on total interest paid over the life of the loan.
- A lower monthly payment, which can make what you owe month-to-month a bit more manageable, but you may end up stretching the loan term to a longer time period and therefore owe more in interest overall.
- A shorter term, which helps you save on interest but could mean a higher monthly payment.
- A fixed interest rate, refinancing from an adjustable-rate mortgage to refinancing to a fixed-rate mortgage before their original interest rate adjusts.
- Tap into your home equity, refinancing to tap into equity and do things like renovations.
But as with any financial decision, you need to understand how refinancing works before rushing into a decision.
How does refinancing work?
When you refinance, you are essentially taking out a new loan to pay off the old loan.
Keep in mind that you’ll likely have to pay closing fees – about 2 to 4% of the total amount you borrow – which can vary depending on the size of the mortgage and the fees you’ll be charged.
It’s always better to have cash available to pay the closing costs, but you may also be able to wrap in the closing costs in with the new mortgage.
Questions to ask yourself before refinancing
How long do I plan to stay in this home? If you’re only planning on living there for a few more years, the cost of refinancing may not be worth it. You’ll want to calculate your break-even point: how many months you need to remain in your home before the monthly savings on the new loan exceed the closing costs you’d have to pay.
How much equity do I have currently? As you make mortgage payments and your home’s value changes over time, the amount of equity you have in the home will also change. Many lenders prefer you have at least 20% equity in your home before you refinance. Some will approve you with less, but you may not get the most favorable terms.
Am I currently paying for PMI? If you have a loan with Private Mortgage Insurance (PMI) and have at least 20% equity, refinancing to a conventional loan may allow you to drop the monthly PMI payment. You may also be able to get rid of PMI by having the home reappraised too, which is much more affordable than refinancing.
How close am I to completely paying off my current mortgage? If you’ve been paying on your mortgage for a while and only have a few years left, it may not make sense to refinance. No sense in trying to save on interest when you’re so close to paying it off.
What mortgage terms would I qualify for now? It might be in your best interest to refinance so you can shorten your loan term from a 30-year rate to a 15- year mortgage at a lower interest rate. Of course, you could always self-amortize the remaining payments (make extra payments to have the loan paid off sooner) if you have the discipline to do so.
How to refinance
Refinancing is just like applying for a mortgage. Go online and get quotes from a few different lenders. Choose one that is offering the refinance options you are looking for at the most reasonable rates.
Once that’s complete, you’ll pay closing costs, sign the necessary paperwork, and begin making your new mortgage payments.