If you want to reduce your interest rate, lower your monthly payment, turn some of your equity into cash in hand, or go from an adjustable rate to a fixed one, refinancing your current loan with a new on makes great sense. In fact, some homeowners refinance more than once over their time in their home. (Most lenders require a six-month “seasoning” period between refinances.) But refinance is the right move for everybody.
Consider these points before refinancing your home:
- You must have equity in your home in order to take out cash against it. Most lenders approve refinances for 80%-90% of the loan’s value.
- Every time you take out equity in your home, you increase the amount of your home loan. So, any cash-out refinances you have taken in the past will reduce the equity available.
- Every refinance carries closing costs, including application, appraisal, and inspection fees, as well as title search and insurance costs. Expect these costs to total between 2% and 3% of your loan amount.
- You will have to meet lender requirements each time you refinance. This includes your credit score, equity, and debt-to-income ratio.
- There may be prepayment penalties for paying off your loan before the end of the term.
Sometimes the numbers don’t add up in your favor.
Be sure and do the math before you pull the trigger on a refinance. Consider these scenarios and, if they apply to your situation, work out the numbers before you opt to refinance.
- Reducing the monthly payments seemed like a good idea….…but thanks to the additional closing costs and fees of a refinance, the money you may save on your payments might be eaten up in the process. Be sure closing costs are part of your financial calculations.
- Cashing out equity for investment money……is only a good idea if you can be sure that the cash you are taking out will earn more than what you’ll spend in refinance costs and mortgage payments.
- Saving money for a new home…if you plan to move within the next two to five years, refinancing may not save you anything. Because of closing costs and fees, it will take you several years to realize any potential savings. If you move within that time, that’s simply money lost.
- Extend the terms of your loan at a lower interest rate…This sounds like a no-brainer but the numbers may not add up. Yes, you’ll pay a lower interest rate each month, but you may actually pay more interest overall over a longer period of time with a longer loan. Calculate the total cost of the loan with those added interest payments.
- Consolidate credit card debt into my mortgage….Hmm. It’s certainly tempting to get out from under high-interest debts with a low-interest mortgage. But here’s the rub: if you can’t make the payments on this new loan, you will lose your home.
You can get many of the benefits of refinance without refinancing.
Consider these options below. If they work for your situation, then you can realize the upside of a refinance without incurring the closing costs or extending the life of your mortgage.
- To own your home sooner, put more toward your loan principal each month. By pre-paying against the principal, you continually move up the day you own your home outright.
- To save for a new home, put more money each month into a savings account. Trim other expenses so you can save even more.
- To reduce other debt, pay off each debt individually, starting with the lowest. Some forms of debt may have payment forgiveness or delay options that may impact your credit, but won’t risk foreclosure.
Make a calculated decision to refinance or not.
Use our Home Loans refinance calculator to estimate what a refinance would save or cost you. Be sure to look at all your options. Calculate your break-even point to see when the costs you incur equal the savings. Divide your mortgage closing costs by the monthly savings of your new mortgage payment; this is the number of months you’ll need to recoup any expenses.