Should I refinance my home?
If you’re considering refinancing your home, you might be wondering about timing. When is the best time to refinance your mortgage? The answer largely depends on your goals. Here are a few of the most common reasons for refinancing a mortgage.
- To lower the monthly payment. If interest rates have dropped since your original mortgage closing, you may consider refinancing to lower the monthly payment. A general rule of thumb is that the new rate should be at least 0.5% to 1% lower than your existing rate.
- A need to get rid of private mortgage insurance. If you made a down payment of less than 20%, you may be paying private mortgage insurance. Once you have at least 20% equity, many lenders will drop this insurance upon request. But if the lender isn’t willing to drop PMI, refinancing is a way to get rid of that expense.
- You need cash from your home equity. You might need cash from your home for home repairs or to consolidate debt. Refinancing gives you the ability to tap into your home’s equity.
- The current mortgage is an adjustable rate. Refinancing allows you to move out of an adjustable rate mortgage, which can increase after a period of time, into a fixed rate mortgage.
- Reduce the home loan term. Refinancing into a shorter loan term can save a significant amount of money on interest. For example, on a 30-year $200,000 mortgage with a 4% fixed rate, you’ll pay around $143,0000 in interest alone over the life of the loan. With a 15-year term, you’ll pay only $66,0000, saving you around $77,000 in interest charges over the current loan term.
Reasons you may not want to refinance
Refinancing your home is a large decision and there are many reasons that you may want to skip this transaction. Here are a few to consider.
You’re planning to move soon. Refinancing a mortgage costs around 2% to 5% of the total loan amount in closing cost. Reaching a break-even point takes time. For example, let’s say that you pay $3,000 in closing cost and your payment drops by $50 a month. Breaking even will take around 60 months, so if you plan to move before then, consider skipping the refinance.
Tapping into equity for short term gains. Funding a home improvement or consolidating debt are common reasons that people tap into their equity. But when tapping into equity, it’s important to ensure that leveraging your equity is providing long-term financial gains.
Refinancing into a longer-loan term. A refinance can result in you paying longer on your mortgage and consequently paying more interest. Let’s say you have 20 years left on your existing mortgage and refinance into a 30-year mortgage. This saves you money each month but adds another 10 years to the life of your current loan. Consider refinancing into the shortest-term home loan that you can afford.
A penalty exists on your existing mortgage. If your existing loan has a prepayment penalty, you might lose any potential financial gains if you refinance. For example, the lender may charge a 2% fee if the loan is paid off in the first year. Get in touch with your lender to determine if a prepayment penalty exists on your mortgage.
Refinancing a fixed-rate loan into an adjustable rate mortgage. An ARM has a fixed interest rate for a short period of time. For example, a loan might have a lower interest rate for the first five years but adjust after that period. This can make a future mortgage payment unpredictable and potentially higher. Therefore, refinancing your fixed-rate loan into an ARM to lower the mortgage payment in the short term might not always be best if you plan to stay in your home.
What’s involved in the mortgage refinance process?
If you’re ready to refinance your home, you might wonder about next steps. The process is similar to a home purchase and typically requires proof of income, financial documents and an appraisal of your home. Most lenders will require the following with home refinances:
- A credit check. Your credit score plays an important role in your mortgage interest rate and your monthly mortgage payments. The lender will run a credit check on all home borrowers.
- A discussion about mortgage loan options. The lender will discuss potential mortgage options with you, including loan terms and mortgage rates. For example, do you want a 15-, 20- or 30 year loan term? Do you want a fixed-rate mortgage or an ARM? The lender can discuss the benefits and drawbacks of each.
- Documents that support your mortgage loan application. Expect to provide your last two pay stubs, W-2s for the past two years, two years of tax returns, bank statements and other financial documents. A copy of your current mortgage statement and homeowner’s insurance policy may also be required.
- An appraisal. Most lenders require an appraisal, which will cost you about $300 to $400. The appraisal will provide an estimated value on your home.
- Close your loan. Expect most loans to close within 30 to 45 days. You will sign closing documents and the loan will fund.
Making the right decision
Refinancing your home is a personal decision that includes a variety of variables. Are you planning to move in the next five years? Do you plan to stay in your home until you pay it off? And what is the ultimate goal of your mortgage refinance? Working out different scenarios using a refinance calculator, such as refinancing into a 15-year versus 30-year loan term, can help you figure out the best path forward.