In deciding whether refinancing is right for you, theres more to consider than just mortgage interest rates.
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Sure, when interest rates are dropping, mortgage refinance tends to be in the news. But falling interest rates arent the only reason it might be the right time to refinance your mortgage.
Read on to find out more about what you should think about before refinancing and the different reasons you might want to do it. Then you’ll be better equipped to decide if its a good time for you to refinance.
Refinancing your mortgage can seem like a smart move when interest rates drop but how do you really know if it’s the right decision for your financial situation? Determining if refinancing is worth it requires careful consideration of several key factors. This guide provides a comprehensive overview of what to consider when evaluating if refinancing makes sense for you.
Assess Your Current Mortgage Situation
First, look at your existing mortgage and determine:
- Your current interest rate and monthly payments
- Remaining loan balance
- Loan term and years left
- Type of mortgage (fixed, ARM, etc)
- Any prepayment penalties
Make sure you have all the key details of your current home loan handy before assessing refinance options. This provides a baseline to compare potential savings and costs.
Check Current Interest Rates
Next, look into the current mortgage refinance rates that are available. Interest rates change all the time, so it’s important to get the most up-to-date rate information instead of relying on ads that say “rates as low as,” which might not apply to you.
Many professionals say that refinancing is a good idea if the new rate is around 1% lower than the old rate. However, even a 0. 5% or 0. Depending on the amount and terms of your loan, a 25% drop could save you money.
Do the math to see how much you could save on your mortgage if you refinanced at today’s rates. Online mortgage calculators can help you figure out when you’ll break even and how much your monthly payments will change.
Factor In Closing Costs
One major factor that can determine if refinancing is worth it is the closing costs you’ll have to pay as part of the transaction. Closing costs typically range from 2% to 5% of your total loan amount.
For a $300,000 mortgage, you may pay $6,000 to $15,000 in various refinancing fees for appraisals, application fees, title insurance, taxes, and more. It’s essential to weigh these upfront costs against your potential long-term savings from reduced interest rates.
Calculate your “breakeven point” by dividing your estimated closing costs by the monthly savings from refinancing to see how long it will take to recoup the upfront expenses.
Assess Your Financial Goals
Take time to consider your financial goals and how refinancing aligns with your overall money situation and plans. For instance:
- Do you want to reduce monthly payments and free up cash?
- Are you focused on paying off your home faster?
- Do you need to tap equity to consolidate other debts?
There are different reasons to refinance, so make sure that your goals match the types of loans you’re looking into.
Compare Loan Terms Carefully
Critically compare all the costs and terms of any refinanced mortgage you’re considering to your current home loan. Look at:
- Loan amount
- Interest rate
- Monthly payments
- Loan term and type
- Total interest paid over the life of the loan
It’s essential to understand how much you’ll pay overall, not just monthly, to determine if refinancing is your most cost-effective option. Don’t just look at potential lowered monthly payments in isolation.
Know Your Break-Even Horizon
To determine if refinancing is worth it, you need to estimate how long you’ll stay in your home. Refinancing often only pays off if you’ll keep the home long enough to recoup closing costs and realize ongoing savings.
Generally, plan to stay at least 5 years after refinancing to make it worth the upfront costs. If you may move sooner, additional analysis is required to see if lower monthly payments still warrant refinancing.
Seek Professional Guidance
Speaking with a mortgage broker or advisor can provide expert perspective on your financials and goals to help decide if refinancing makes sense for you. Their market insights and mortgage comparison tools can give you confidence in your decision.
Refinancing seems worth it when rates drop but requires thorough financial analysis of your situation and goals. By following this guide and crunching the numbers carefully, you’ll know if the time is right to refinance your home loan.
What to know before you refinance
No matter your reason for refinancing, youre going to want to figure out a few numbers before you apply.
- Your current interest rate. Check your most recent mortgage statement to make sure you know what your interest rate is. It’s important to know the real number, not just about 6%, because even small parts of a percentage point can add up. You can figure out how much you’d save if rates have gone down. But if rates have gone up, you should think about whether the other benefits of refinancing are worth the extra interest.
- An estimated amount for your refinance. Whether you just want to refinance the amount you still owe on your mortgage or want to take out a bigger loan, you should also keep that amount handy. There are closing costs that come with refinancing. Usually, they are between 2% and 6% of the amount of the new loan. You can guess those costs if you know how much you’re going to borrow.
- How long you plan to stay in the house. You need to know your break-even point if you want to save money by refinancing. That is when the money you saved by refinancing is more than what you paid for closing costs. Let’s say you pay $3,600 in closing costs to save $100 a month. It will take 36 months ($3,600 / $100 = 36) to break even. You must stay in the home for at least three years after your refinance in order to save that much money.
You could save by changing your home loan’s term
When you refinance, you can change more than just the interest rate. You can also change the term, or length, of your mortgage.
When they can afford it, many people refinance from a 30-year to a 15-year loan. Paying off your loan over a dramatically shorter amount of time usually means significantly higher monthly mortgage payments, but it can also substantially lower the amount of interest paid over the life of the loan.
You can also refinance to a longer term. That can lower your monthly payments, because youre paying over more time. But youre also paying more interest because youve extended the life of the loan.
If you’re already 10 or more years into your loan, refinancing to a new 30-year or even 20-year loan — even if it lowers your rate considerably — will tack on interest costs. That’s because interest payments are front-loaded; the longer you’ve been paying your mortgage, the more of each payment goes toward the principal instead of interest.
You don’t have to change the term, though. You can refinance to the same date that your current loan is due. That strategy can be useful when you want to pay off the mortgage by a certain deadline, like before you retire. For instance, if you refinance a 30-year mortgage that is only five years old, you can ask to pay off the new loan in 25 years. Ask the lender to amortize the mortgage for 25 years (or whatever number of years you wish).
Ask your lender to run the numbers on different scenarios so you can see how your costs might change depending on your loans term.
Refinance 101 – Mortgage Refinance Explained
FAQ
At what point is it worth it to refinance?
For most borrowers, the ideal time to refinance is when market rates have fallen below the rate on their current loan.
How to know if it makes sense to refinance?
Historically, the rule of thumb has been that refinancing is a good idea if you can reduce your interest rate by at least 2%. However, many lenders say 1% savings is enough of an incentive to refinance. Using a mortgage calculator can help you see how much you might save.
What is a good rule of thumb for refinancing?
A good rule of thumb is to refinance when you can reduce your interest rate by at least 2%. For example, a $250,000, 30-year fixed-rate mortgage at 7% interest has a monthly principal and interest payment of $1,663. Refinancing at 5% would reduce your payment to $1,342 – a substantial savings.
What’s the downside to refinancing?
Refinancing allows you to lengthen your loan term if you’re having trouble making your payments. The downsides are that you’ll be paying off your mortgage longer and you’ll pay more in interest over time.