by Tom Murphy
NMLS # 662141
Home Services Lending
Getting a new mortgage loan on your home to replace the first one is known as refinancing. The most common reason to refinance a mortgage is to get a better term and lower interest rate, both of which will save you money in the short and long term.
Here’s how a refinance works: The first loan is paid off, and then a second one is created. You now have a new mortgage loan on the same property with the same loan balance you had before, but usually at a lower rate and/or with better terms (such as a 15 year loan rather than a 30 year loan). If you have a really good credit history, refinancing your mortgage can be a good idea to convert your adjustable mortgage to a fixed rate, and also possibly get a lower interest rate.
How to Know When to Refinance
1. Lower Interest Rate
The biggest reason that most people refinance their mortgage is to drop their interest rate. A lower interest rate can be possible for many reasons. The most common reason is that current economic conditions are such that mortgage interest rates are lower than when you took out your loan.
For example, as of fall 2016, mortgage interest rates are hovering under 4%, with some 30 year loans at 3.65% and 3.75%. In the mid 2000s during the housing boom, interest rates were more often in the 4.5% and 5% range due to higher economic growth and activity.
If you took out your loan in the early 2000s, it is likely that you could refinance into a lower that might be .5% or even 1% lower. This could save you at least $200 to $400 per month in interest charges. That is, if you have good enough credit to get the best rates.
- Look for Lower Rate Opportunities without Increasing Your Mortgage Balance
- Search for Fixed Rate Terms with No Penalties for an Early Pay-Off
- Shop for Companies that Have Competitive Rates, Low Fees and a Solid Reputation for Refinance Mortgages
Another reason you may be able to get a lower rate is that you are making more money, and your credit score has risen over the last few years. With a higher credit score, you may be able to get a lower cost loan. So, you know it is a good time to refinance your mortgage if interest rates are significantly lower than they were when you took out your loan, OR you have the credit score today that would allow you to refinance for a substantially lower rate. If the difference in rate is less than 1/4 of a point, by the way, you may want to rethink a refinance. With closing costs, it may not be worth it to take out a new loan.
2. Lower Monthly Payment
If you have a lower interest rate of any substantial amount, this will lower your monthly payment by a good amount. Usually, if you are going to stay in the home more than a year or two, saving $100 or more on your monthly payment will make refinancing a good idea.
If you plan to move next year and you only are saving $80 per month, you probably want to hold off on a refinance; the closing costs of several thousand dollars will eat up any short term savings that you realize.
3. Major Purchase
Many people will refinance their mortgage to pull out equity for a major purchase. There are many reasons for people to pull out cash and refinance to fund a purchase:
- Major repair
- Home renovation
- Pay off other debts
- College education
- Starting a business
One of the most popular reasons to pull out equity in a refinance is to pay off debts. However, it is questionable at best if this is a good idea. While it can help you to save a lot on interest over time, if you are just going to run up debt again, doing this is a bad idea. On the other hand, pulling out cash to do a renovation or addition to your home can be a very smart financial move. If the renovation is done affordable and not excessively, it can add substantial value to your home when you resell it. So, you know it is a good time to refinance your mortgage if you have a legitimate and sound reason to pull cash out of your home.
4. Refinance to Avoid Balloon Payment
A balloon program on your mortgage will help you in the short term to keep your early monthly payments low. However, at the end of your fixed rate term, usually after five or seven years, if you still owe, then the entire balance is due. With a balloon, you can take out a new mortgage, either a fixed rate or adjustable. Obviously, refinancing a balloon mortgage makes sense if you do not have the cash to pay off your first mortgage balance.
5. You Have 20% Equity in the Home
There are many 3.5% and 5% down payment programs available to buy a home today. The catch on those is that you have less than 20% equity in the house. So, you must pay private mortgage insurance or PMI. This protects your lender if you default on your loan. But, as your loan balance drops and the value of the home rises, you will eventually get to approximately 20% equity in the property. You can cancel your PMI insurance with a mortgage refinance. If you are getting close to 20% equity in your home, you should talk to your lender about a possible refinance, as this is a good idea to save you a $200 per month PMI payment, in some cases.
6. You Have Solid Investment Opportunities
This is a less common reason to refinance, but it can make a lot of sense in certain situations. Let’s say you have $50,000 of equity in your home and plan to refinance to lower your rate.
You could pull that cash out of your home during the refi at a very low rate, possibly 4%. That money can then be put to work in other investments, IF you are very confident that the investment is going to earn at least double the rate you are paying on the loan.
There are many solid real estate investments that will pay 10% a year or better on average. You just need to be 100% certain that the investment is on solid footing.
*Please check with bank or lending source on current interest rates on a refinance program that you qualify with your credit score and credentials. The information contained on RefiGuide.org is for informational purposes only.