When Should I Refinance My Mortgage?
If you've looked at your mortgage statement recently and wondered, "When should I refinance my mortgage?" you're not alone. While refinancing your mortgage can be a powerful financial decision, it pays to know the details before making the leap.
Here's what you need to know to make an informed decision about refinancing.
What Does it Mean to Refinance My Home?
When you refinance your mortgage, you're replacing your existing mortgage with an entirely new mortgage. Here are some of the reasons people refinance their mortgages:
- To shorten their loan term (e.g., from 30 years to 15 years)
- To lower their monthly payment
- To consolidate debt
- To switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, or vice versa
There are two basic types of refinancing:
- Rate-and-term: This allows you to refinance your existing mortgage balance in order to change the interest rate and/or term of the loan without advancing new money on the loan; the term is the number of years it will take to pay off your mortgage, assuming you always pay the amount due on time. This differs from a cash-out refinance in which the new money is advanced.
- Cash-out: For homeowners with equity in their homes, you'll take out a new mortgage for more than your current loan's balance. From there, you'll receive the difference between your current mortgage balance and the new mortgage in cash.
If interest rates are lower now than when you bought your home, you could lower your monthly payment and potentially, overall interest paid by refinancing.
With this critical financial information in hand, you may still be wondering "when should I refinance my mortgage?"
Total Interest You'll Pay on Your Mortgage
Say you bought your $200,000 home in 2010 when interest rates averaged 6.46 percent and you took out a 30-year, fixed-rate mortgage. If you refinance your remaining balance of $173,404.07 at 3.25 percent for a 15-year term, you'd save over $110,407 in interest costs compared to the remainder of your 30-year term.
If your current monthly payment is roughly $1,259, your new payment would be approximately $1,218 and you'd pay one point (1% of the loan amount) upfront in origination costs. A small investment with your refinance up front can add up to substantial savings and have your mortgage paid-off faster to boot.
If You're Concerned About Your Monthly Payment
Maybe you're only a few years into your mortgage and you bought a $250,000 home at 5.75 percent on a 30-year fixed-rate mortgage. Now, interest rates are roughly 4.5 percent. If you refinance your mortgage of nearly $200,000 to a new 30-year term, here's how that math shakes out:
- Current Mortgage: $250,000 at 5.75 percent for 30 years = $1,459
- New Mortgage: $200,000 at 4.5 percent for 30 years = $1,013
However, if you're nearing retirement you should proceed with caution. Re-extending your loan term means paying longer, so you'll want to make sure you're prepared to continue payments no matter what your plans for the near future may be.
Are There Any Fees to Refinance My Mortgage?
As you think through refinancing your mortgage, don't forget about loan origination fees and closing costs. On average, your closing fees can total between 2 and 8 percent of the amount you refinance. That being said, these fees can sometimes be included in the cost of refinancing. Schedule an appointment and speak to a mortgage loan officer to better understand your options.
What About Interest Rates?
As you shop for refinance interest rates, you might find that you're quoted rates that don't align with the rates you see advertised online. This is probably your credit score talking.
Banks offer the best interest rates to borrowers with exceptional credit. Banks will still lend to homeowners with lower credit scores, but the interest rates will be slightly higher. Prepare in advance to receive the best possible rate by pulling your credit report, checking to see if you can lower or pay off balances, or taking care of any outstanding debts in hopes of gaining a better score.
Do you have a checking account along with a savings or investment account with a financial institution that you know and trust? If so, see if you can leverage your relationship with your bank for a lower interest rate.
Doing the Math
Your financial goals, the equity in your home, and whether the math for refinancing makes sense for your situation are all factors to take into consideration.
Consult with a mortgage loan officer to talk about your financial plans and see if refinancing is an option to put you in the ideal position to navigate the road ahead.