If you’ve taken the plunge and bought a house, you may have thought your big decisions were over for a while. Think again – at least, if you’d like to save money on your mortgage. The option to refinance is a constant question for homeowners to consider, especially when rates are as low as they are. The thing is, you’ve got to know when those low rates mean real savings and when they just mean hidden costs. Read on for tips on how to know when to refinance.
Worth considering?
Unless you’ve got money to spare, a refinance is always worth considering. It can be a great money saving tool if you take advantage of it at the right time. But that’s the point – refinancing your mortgage is only a good idea if it suits your particular situation.
Too many people jumped into the refinance game after the bank bailouts. Their decisions were solely based on the fact that the mortgage rates dropped by a quarter to a half a percentage point, depending on timing.
Regardless, a drop in the interest rate shouldn’t dictate a rush to renegotiate your mortgage. Instead, take the time to consider several key factors before moving ahead to refinance.
Why you might want to refinance
The main reason to refinance your home is to reduce your monthly mortgage payment. Other reasons include reducing the interest you pay over time or reducing the life of your loan. Sometimes it’s even possible to reduce the principle owed on your mortgage, especially when your home has increased in value.
Refinancing also comes into play as a wise option if you’re looking to make home improvements or pay off consumer debt. Though this method won’t help lower your overall payments, it can supply you with a much needed cash infusion.
What you need to know before refinancing
First off, you must be able to answer some basic questions about your current mortgage. These questions include:
- What is your current interest rate?
- Are you paying a fixed or variable rate?
- What is the value of your home, and has that value increased since you purchased your home?
- Do you have cash to spare for the closing costs of refinancing?
- Do you plan to stay in your home at least three more years?
When to refinance
If you’re sure refinancing will be worth your while, then go for it. But to get to that point, you need to speak with your lender to find out the pros and cons. Generally speaking, if you can shave about two percentage points off your mortgage then refinancing will make sense.
Depending on your situation, it may make sense even when you save less than that. For example, if you currently have an adjustable rate mortgage (ARM), it could be a wise move to switch to a fixed rate mortgage. You’ll have more security by foregoing the risk associated with an ARM. After all, a large chunk of the housing crisis occurred when rates went up and people with adjustable rate mortgages could no longer make their payments.
When NOT to refinance
If you’re tempted to refinance your home on a yearly basis to pay off consumer debt, don’t. You’d actually be hindering your financial progress by constantly extending the life and principle balance of your loan – a move that can leave you with long-term negative consequences.
You should also avoid a refinance if you’re short on the money it’ll cost you for the overall transaction. Too often, homeowners allow lenders to fold closing costs from a refinance into the balance of the refinanced loan. They don’t realize the substantial fees involved with a refinance, especially if you’re a high-risk borrower. This process only extends your debt and moves you further away from actually saving money on your refinance.
Another reason to avoid a refinance is if your credit score is low. Because your interest rate is tied to your credit score (as is the total amount you can borrow), you’d be doing yourself a disservice if you refinanced while your score was low. Instead, take the time to improve your credit rating and you’ll almost certainly end up with a better deal on a refinance.
Do the dirty work
Refinancing your home is particularly tempting once you’ve found a lender you trust. More than likely you’ll want the lender to fund your refinance and you’ll skip all the extra precautions you probably took while shopping for your original loan.
Instead, do the dirty work. Shop multiple lenders and compare prices. Look at fees. Calculate the amount of time it will take you to recoup the cost of refinancing.
Take advantage of internet calculators designed specifically for refinancing questions – they’ll save you a great deal of time and effort in the long run while still supplying you with the information you need to make your decision.
