You’ve heard about the benefits that can come from refinancing your mortgage, like possibly saving you money on your monthly mortgage payments, helping you afford home renovations or even getting your finances back on track, if done correctly.
But how do you know if it’s right for you? These are four questions to ask yourself to help you understand if this option is right for your specific situation.
1. Why Do You Want to Refinance?
It’s good to think about your reasoning and what you hope to gain by refinancing your mortgage before you speak with your lender — and there are a lot of common reasons as to why someone would be considering refinancing their home loan. Here are some of them (and when they might be a good option).
Lowering the Interest Rate — Generally, you should consider refinancing if you can lower your interest rate by at least 2%. If interest rates are low, especially if they’re lower than when you initially got the loan, it is possible you could save a lot by refinancing your mortgage.
Changing the Type of Loan – If you currently have an adjustable rate mortgage (ARM), you may want to switch to a fixed rate mortgage (FRM) in order to lock in the lower rate for a longer period of time. Alternately, you may be able to reduce your current payments by switching from a FRM to ARM.
Avoiding a Balloon Payment — Some mortgages have a large payment due at the end of the loan term (usually five to seven years). You may need to refinance your loan in order to avoid having to pay this “balloon payment.”
Stop Paying Private Mortgage Insurance — Private mortgage insurance (PMI) is sometimes required by lenders if you had to borrow more than 80% of the home’s sale price. If the home’s value has increased, you can use this amount to refinance and stop paying PMI.
Cashing Out Home Equity — Home equity is often used to finance a remodeling project, college tuition, car purchase or vacation. If your home’s value has increased, you can do a cash-out refinancing up to this extra amount and use it toward whatever expenses you might have.
Consolidating Debts — If you have a lot of high interest debts, you may be able to save by consolidating these debts into a mortgage. Auto loans, credit cards, second mortgages and other debts can be included in your refinance.
2. How Are Your Finances?
Before you start filling out the refinancing paperwork, you’ll want to think about your current financial situation, and that includes your credit. If you haven’t checked your credit in a while, now is the time to do so. You can get free copies of your credit reports from the three main credit bureaus — TransUnion, Equifax and Experian — when you visit AnnualCreditReport.com. You can also see two of your scores for free on Credit.com. It’s important to note that reviewing your own credit reports and scores does not affect your credit in any way.
Your Credit and Finances Improved — If your credit scores have improved since your last mortgage application, you may be able to reduce the interest rates on your loan by refinancing. You can also save by refinancing if other financial indicators such as your debt, income, and savings have improved.
Your Credit and Finances Haven’t Changed — If your credit scores and financial situation have not changed since you first got your mortgage, you may or may not be able to save by refinancing. That doesn’t necessarily mean you definitely shouldn’t refinance, but it’s a good idea to look at recent interest rate changes and consider your reasons for refinancing before you apply.
Your Credit and Finances Are Worse — If your credit scores have decreased, you may not be able to save money by refinancing. Even if interest rates have dropped, you may not qualify for the lower rate because of your credit scores. Estimate what mortgage rates you could receive based on your scores and consider your reasons for refinancing before you apply. You may also want to take steps to improve your credit scores, like being more diligent about making on time payments, paying down debt and remedying any errors on your credit reports.
3. How Much Will It Cost You to Refinance?
While a lower interest rate will mean lower monthly payments and less money going toward interest payments, a refinance will also mean paying closing costs and, in some cases, points (fees that go to the lender in exchange for a lower interest rate). If the monthly savings exceeds these expenses, refinancing could be a good option.
Keep in mind the associated costs can vary from lender to lender, so you’ll want to be sure to shop for the best mortgage options available to you. Get a loan estimate from each lender. It will detail the loan terms, projected payments and estimated closing costs and fees. Your potential lenders legally have three days to get an estimate to you from the time they receive your information.
4. Are There Reasons Not to Refinance?
Just like any other financial decision, you should do your research to make sure this option is right for you. And, of course, there are going to be times when it isn’t the best route. Above all, if you won’t save money once the closing costs and other expenses are considered, refinancing might not be worth your time and effort. But it can be more than that. Here are some other factors to consider.
You Are Moving Soon — Refinancing costs usually take a year or so to pay off before you’ll start seeing the savings in your mortgage payments. So, if you know you’ll be packing boxes by the time you break even, you may want to reconsider about changing the terms of your loan.
Your Loan Has a Prepayment Penalty — There are some lenders out there that add prepayment penalties to a borrower’s mortgage. These penalties charge you expensive fees if you sell or refinance your home before a certain amount of time has passed (typically one to five years from the original loan date). If this is the situation you’re in, you can calculate if the savings you may see from refinancing would outweigh the fees. If not, you may want to hold off on refinancing and reevaluate once your prepayment penalty restrictions have lapsed.
You Are Close to Paying Off Your Mortgage — If you are close to paying off your mortgage, it may make sense to wait instead of refinance, even if the terms on a refinance would be better than your current ones. Refinancing can extend the term of your loan and increase your costs, making it not worthwhile in the long term.
You Are Having Financial Problems — If you are having major financial problems, you may want to reconsider refinancing as a way to consolidate your debts or borrow money. In some situations, refinancing your home could be put at risk if your financial problems continue.
Once you’ve made these considerations, you’ll have a better sense whether or not refinancing your mortgage makes sense for you.