For the average homeowner, their mortgage is the single largest debt and monthly payment. Thus if you have the opportunity to get a better rate and more favorable terms, it makes sense to at least explore the option. But do you know what you’re doing?
Many people avoid refinancing for years. They do so because of a lack of education on the topic and/or the perceived hassle. But in truth, refinancing your mortgage can be one of the most important financial decisions you make in years. Here’s why:
Pay less interest. The ultimate goal of a refinance is to pay less interest. And if you’re planning to be in the house for another five, 10, or 15-plus years, a lower rate could potentially save you tens of thousands of dollars.
Lower payment. One of the obvious byproducts of lowering your interest rate is the ability to lower your monthly payment. Whether it’s $150 or $1,000 per month, every little bit adds up.
Cash-out. If you’re able to lower your interest rate and simultaneously take cash out of your home, this may be a wise option. You can use this cash to bolster your emergency savings, fund other investments, or even make home improvements.
Greater stability. If you’re currently in an adjustable rate mortgage (ARM), refinancing may allow you to secure a fixed rate. This eliminates some of the uncertainty and risk of a ballooning mortgage rate.
4 Tips for Refinancing
If you already have an interest rate that’s competitive with today’s rates, then there’s no need to refinance. But if you’re stuck at a much higher rate, there’s clearly much to gain. Here are some helpful suggestions:
Shop Rates Online
No matter how healthy your relationship is with your banker or local credit union, approaching one lender for a refinance is a mistake. In order to get the possible rate, you need to shop around. By using a broker or online comparison site, you can ensure you get the best possible deal – meaning both a competitive interest rate and favorable terms.
Look Beyond Interest Rate
You obviously want to look for the lowest possible interest rate. But you should know that an interest rate is just one part of the equation. You also have to think about the type of mortgage and the repayment period.
If the goal is to improve your present cash flow by lowering payments, then yes, the lowest possible interest rate is what you’re seeking. But if you’re ultimately interested in saving money over the long run, there are other variables in play. For example, you might be better off refinancing from a 30-year mortgage into a 15-year mortgage – even if it means paying more per month. (Every situation is unique, but understand that there are a variety of factors involved.)
Consider Closing Costs
Refinancing your mortgage can cost somewhere in the range of 2 percent to 5 percent of your total loan amount. Thus you have to take these costs into account when refinancing.
Your break-even point is the first thing to consider. If you’re paying $5,000 to refinance and it’s going to save you $250 per month, your break-even point is 20 months. This means it’ll take you a little over a year and a half just to earn enough savings to justify the refinance fee. After that, everything is cash in pocket.
Secondly, you have to decide how you’ll pay for the costs. Will you do it out of pocket or roll them into your mortgage?
Know When to Pull Equity vs. Leave it In
When refinancing, there are a number of approaches you can take. A cash-out refinance is one of them. In this situation, you actually pull out some of the equity you currently have in the house. This money can then be used to fund other purchases or investments. In other situations, you leave all of the cash in the new mortgage.
The only time it makes sense to pull out equity is if you have a smart use for the money (vacations and cars don’t count) and your payment is still lower. If that’s the case, it might be a fine decision. You’ll have to make that call on your own.
Making the Right Decision
Refinancing doesn’t make sense in every situation. But when it does, it’s important that you do your due diligence and find the best possible rate and terms to fit your needs. Keep these tips in mind and you’ll increase your chances of securing the right deal.