The decision to refinance your home depends on many factors, including the length of time you plan to live there, current interest rates, and how long it will take to recoup your closing costs. In some cases, refinancing is a wise decision. In others, it may not be worth it financially.
Because you already own the property, refinancing likely would be easier than securing a loan as a first-time buyer. Also, if you have owned your property or house for a long time and built up significant equity, that will make refinancing easier. However, if tapping that equity or consolidating debt is your reason for a refi, keep in mind that doing so can increase the number of years that you will owe on your mortgage—not the smartest of financial moves.Reasons to Refinance
So when does it make sense to refinance? The typical should-I-refinance-my-mortgage rule of thumb is that if you can reduce your current interest rate by 1% or more, it might make sense because of the money you’ll save. Refinancing to a lower interest rate also allows you to build equity in your home more quickly. If interest rates have dropped low enough, it might be possible to refinance to shorten the loan term—say, from a 30-year to a 15-year fixed-rate mortgage—without changing the monthly payment by much. Similarly, falling interest rates could be a reason to convert from a fixed- to an adjustable-rate mortgage (ARM), as periodic adjustments on an ARM should mean lower rates and smaller monthly payments. In a rising-mortgage-rate environment, this strategy makes less financial sense. Indeed, the periodic ARM adjustments that increase the interest rate on your mortgage may make converting to a fixed-rate loan a wise choice. Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
Consider Closing Costs
There are closing costs involved in all of these scenarios. Your outlay will need to cover charges for title insurance, attorney’s fees, an appraisal, taxes, and transfer fees, among others. These refinancing costs, which can be between 3% and 6% of the loan’s principal, are almost as high as the cost of an initial mortgage and can take years to recoup.If you are trying to reduce your monthly payments, beware of “no-closing-cost” refinancings from lenders. Although there may be no closing costs, a bank likely will recoup those fees by giving you a higher interest rate, which would defeat your goal.
Consider How Long You Plan to Stay in Your Home
In deciding whether or not to refinance, you’ll want to calculate what your monthly savings will be when the refinance is complete. Let’s say, for example, that you have a 30-year mortgage loan for $200,000. When you first assumed the loan, your interest rate was fixed at 6.5%, and your monthly payment was $1,257. If interest rates fall to 5.5% fixed, this could reduce your monthly payment to $1,130—a savings of $127 per month, or $1,524 annually.Your lender can calculate your total closing costs for the refinance should you decide to proceed. If your costs amount to approximately $2,300, you can divide that figure by your savings to determine your break-even point—in this case, the home for two years or longer, refinancing would make sense one-and-a-half years in the home [$2,300 ÷ $1,524 = 1.5]. If you plan to stay in the home for two years or longer, refinancing would make sense.If you want to refinance with less than a 1% reduction, say 0.5%, the picture changes. Using the same example, your monthly payment would be reduced to $1,194, a savings of $63 per month, or $756 annually [$2,300 ÷ $756 = 3.0], so you would have to stay in the home for three years. If your closing costs were higher, say $4,000, that period would jump to nearly five-and-a-half years. If the equity in your home is less than 20%, you could be required to pay PMI, which could reduce any savings you might get from refinancing.
Consider Private Mortgage Insurance (PMI)
During periods when home values decline, many homes are appraised for much less than they had been appraised in the past. If this is the case when you are considering refinancing, the lower valuation of your home may mean that you now lack sufficient equity to satisfy a 20% down payment on the new mortgage. To refinance, you will be required to provide a larger cash deposit than you had expected, or you may need to carry PMI, which will ultimately increase your monthly payment. It could mean that, even with a drop in interest rates, your real savings might not amount to much. Conversely, a refinance that will remove your PMI would save you money and might be worth doing for that reason alone. If your house has 20% or more equity, you will not need to pay PMI unless you have an FHA mortgage loan or you are considered a high-risk borrower. If you currently pay PMI, have at least 20% equity, and your current lender will not remove the PMI, you should refinance.