Borrowers tend to consider refinancing their mortgage when interest rates fall. However, there may be various reasons why a specific period is appropriate to replace your existing loan with a new one.
There are several refinancing options available. Each option comes with its own pros and coons.
Here’s how to determine when a refinance makes financial sense for you and when you should consider other options.
Key Takeaways
- Refinancing your mortgage may be suitable for a variety of reasons, including reduced interest rates, cash out, or converting to a fixed-rate loan.
- For most borrowers, the best time to refinance is when market rates have gone below the rate on their current loan.
- If you want to refinance, calculate the break-even point so you know how long it will take to see the savings.
When You Should Not Refinance
Refinancing may not be the best option if:
- You will splurge on discretionary purchases
Don’t put your property at risk by using refinance savings or cash-out profits to pay for one-time costs like a vacation or car. In general, it is advisable to save for these expenses.
- You’re far along in your mortgage
If you’re halfway through the loan term, refinancing will not save you money. You’ve already reached the point where more of your payment goes to loan principle than interest; refinancing now means restarting the clock and paying more for interest.
- Your other financial objectives will suffer
Paying off your loan early is usually good, unless you sacrifice critical financial goals, such as preparing for an emergency or retirement.
- You will pay a higher interest rate
If your credit score is low, or current interest rates are significantly higher than when you took out your mortgage, refinancing will increase the overall cost of your loan.
- You intend to sell your house soon
If you want to sell your house soon, it is very unlikely that you will remain in the property long enough to recover the refinancing costs.
- Your existing mortgage has a prepayment penalty
The penalty must be referred to as a refinancing cost and must be assessed accordingly. Although this is a one-time fee, it will affect your capacity to quickly recoup your refinance costs.
When Should You Refinance Your Home?
Refinancing your mortgage is a major move. As a result, there are various factors to consider before signing the document. Most borrowers consider mortgage rates before deciding to refinance.
Locking in a lower rate is a crucial element to consider when refinancing because it reduces your monthly payments. However, when it comes to renewing your mortgage, it should not be your sole priority.
Here are a few more factors to consider before applying:
- Your home equity. Make sure you have equity in your home. This is especially important if the value of your home falls below what you paid for it. If you don’t have satisfactory equity in your property, many lenders (particularly traditional lenders) will not refinance your mortgage.
- Your credit history. If your credit score falls below the minimal requirements, you will be ineligible for a refinance. Make sure to improve your credit score before applying.
- Refinancing costs. If you have a mortgage, you will know how much you paid in extra fees. As a result, you will have to pay these expenses again—usually a small amount of the loan. Try to discover ways to negotiate and decrease the costs.
Other factors to consider are your debt-to-income (DTI) ratio, the total length of the refinance, and whether you qualify for refinance points to lower the loan’s interest rate.
In addition to all that, you should also consider whether refinancing makes sense. How long do you think you will stay at the property? Will refinancing save you more money?
Answering these questions will help you determine whether or not to take this action.
Reasons To Refinance Your Mortgage
Many borrowers find it beneficial to refinance if they can lower their interest rate and intend to stay in their property long enough to recoup the refinancing closing expenses.
Here are the main reasons to consider refinancing.
Lower your interest rate
If interest rates have fallen since you obtained your mortgage, a rate-and-term refinance may provide you with a reduced rate. The ideal rate would be one-half to three-quarters of a percentage point lower than your current rate.
If your credit score has improved since you took out your existing loan, you can be eligible for a lower interest rate.
Check your score and credit report before applying. Mortgage refinance rates are best for those with a score of at least 740.
Pay For Large Expenses
With a cash-out refinance, you can tap into the equity in your house. It can help you to obtain immediate cash. You can utilize these funds for whatever you want, including:
- Lowering or repaying high-interest debt
- renovating your home
- Paying college tuition
- Investing in Property
Eliminate Private Mortgage Insurance (PMI)
If the value of your house has increased, boosting your equity holding, you may be able to refinance your conventional loan and eliminate private mortgage insurance (PMI) payments immediately, or at least earlier.
Change Your Loan Structure Or Term
If you’re not far into repaying a 30-year mortgage and wish to pay it off sooner, you can refinance to a shorter loan term, such as 15 years. This will also save you money in interest payments.
Similarly, if your adjustable-rate mortgage is due to reset and enter the variable-rate phase, you could refinance into a fixed-rate loan to ensure consistent monthly payments.
The Bottom Line
Refinancing can be a wise financial decision if it lowers your mortgage payment, shortens the length of your loan, or provides cash for unexpected costs.
However, it could lead to hefty closing expenses and fees, so you may not see savings for several years.
Before refinancing, you should evaluate how long you intend to stay in your house and compare your possibilities with a mortgage calculator.