- Posted by Jeremy Bachmann
Interest rates have reached their lowest levels since the 1960s. And, a mortgage refinancing flurry has swept through the housing market. According to the Mortgage Bankers Association and HUD, 16.2 million homeowners have refinanced since April 1, 2009. But, is refinancing right for everyone?
Well, it depends on many different factors, including: how long you plan to live in your home; what loan term works best for you; your current interest rate; your remaining loan balance, and your credit score. Each of these considerations can affect how much money refinancing will actually save you in the long run.
So, before you jump on the mortgage refinance bandwagon, here are a few questions to consider.
How Long Do You Plan To Live In Your Home?
Just as when you initially purchased your home, you will have to pay closing costs on your refinance, too. Processing, underwriting, and appraisal fees are just a few of the extra expenses you'll incur before you can close that new loan. And, unfortunately, these fees can really rack up. Typically, homeowners will spend at least $5,000 on closing costs. And, in some cases, closing costs can be so high that borrowers barely break even after refinancing a mortgage.
Therefore, lenders often recommend that homeowners live in their homes for at least two years after a refinance. This gives the borrowers time to recover the expenses associated with closing costs. For example, if your closing costs are $5,000, after two years, your savings in monthly payments should at least equal $5,000.
So, remember, the longer you stay in your home, the more you'll be able to reap the full benefits of a refinance's lower monthly payments.*
Do You Need Flexibility or a Rigid Schedule?
A common use for refinancing is to shorten the length of a loan and pay it off earlier. If rates have dropped enough, it's common to keep the same monthly payment while shaving years off your mortgage.
For example, often people with a 30-year mortgage will refinance to a 15-year loan. This can be a great choice, but there are things to consider.
First, most lenders will allow you to pay off your mortgage early. So, if you want to pay off your 30-year loan in 15 years by making extra payments, you can. This can help you build equity faster and save on interest payments! But, if circumstances change and times get tough, you have the freedom to go back down to your original, lower mortgage payment.
On the other hand, a 15-year loan typically offers even greater interest savings, and it helps you build equity quickly, so you can own your home free and clear sooner rather than later.
What's Your Current Interest Rate?
One of the best reasons to refinance is to lower the interest rate on your existing loan. Lower interest rates help decrease your monthly payments and, most importantly, help you save some money.
A typical rule of thumb is – if you can reduce your current interest rate by 1%, then it is worth refinancing. And with interest rates reaching historic averages of 3.23%, now might be a great time for homeowners to consider a lower-rate loan.
For example, if you were to reduce the interest rate of a 30-year, $200,000 mortgage by even just 1%, let's say from 6% to 5%, you could save over $45,000 in interest payments over the life of the loan – now that's a lot of spare change!
Still, rules of thumb are just that. If you aren't planning on moving anytime soon, interest rate reductions of less than one percent can more than pay for themselves, even with closing costs rolled in.
What's Your Remaining Loan Balance?
Before signing that new mortgage, make sure you assess your current loan balance. If you're currently on the 15th year of your 20-year loan, you are most likely paying all principal with each monthly payment. This means you're finally building up your equity, following years of costly interest payments.
If this sounds like you, you may want to forgo refinancing, especially if you're considering switching to a longer-term loan. Why? Well, even though refinancing from a 20-year to a 30-year mortgage can lower your monthly payments, you will inevitably end up paying more money over the course of that new loan.
Remember, you pay more in interest on a longer-term loan than you do a shorter-term loan. So, if you were to refinance to a longer 30-year loan, you would essentially be starting all over again with interest payments. And, this could easily outweigh any monthly savings you might have gained from a refinance.
What's Your Credit Score?
Your credit score not only helps determine your mortgage refinance approval, but it also determines the interest rate a lender offers. Simply put, the higher your credit score, the lower your interest rate. For example, a borrower with an average loan size and a credit score of 620 can expect to pay around $2,500 more a year in interest payments than a borrower with a credit score of 760. If your credit score has fallen since you first obtained your mortgage, you could expect to pay higher rates that may negate any potential savings.
Is Now the Right Time to Refinance?
Ultimately, if you think you're in the ballpark, take 10 minutes to call your lender to see if the numbers make sense for your financial situation. Even if you tried unsuccessfully to refinance in the last year or so, programs and rates have changed enough, along with rising home values in many markets, that you may be able to reduce your rate or monthly payment this time.
* By refinancing your existing loan, your total finance charges may be higher over the life of the loan.