When is it Time to Refinance?
You’ve been hearing it everywhere, interest rates are at record lows. Everyone is saying that now is the time to refinance, as interest rates continue to drop. But how do you know if it's the right time for you?
The decision to refinance your home should be well thought out. Like anything else, refinancing has its good points and bad. Trying to predict the best time to refinance can be like trying to predict the weather in Chicago — impossible and slightly dangerous. But there are some gauges you can use to decide if refinancing makes sense for you.
There are many motives for refinancing your home mortgage, but the most common reasons to refinance are to lower your interest rate thereby lowering your monthly payment; to reduce the length of your mortgage to save thousands of dollars in interest; to use your equity for home improvements or other large expenses; when interest rates are low, to lock in a constant interest rate if you have an adjustable rate mortgage (ARM); when rates are high, to convert to an ARM to lower monthly payments; if your mortgage has a balloon provision with no conversion option; and/or for debt consolidation.
While all the above refinancing reasons are legitimate and reasonable, there are many factors to consider. For instance, it will be identical to the process you underwent when securing your original mortgage — requiring an application, credit check, title search, appraisal, etc. This process, as you already know, is time-consuming and often expensive. Refinancing is NOT free. There are bank fees, appraisal inspection fees, lawyer’s fees, points and closing costs, just like the first time around. If you are frightened by the thought of going through that process again, you might not be quite ready to refinance (or, you might need better professionals on your side).
Calculating Your Savings
So how do you calculate what rate you need for refinancing to be worthwhile? The interest rate isn’t the only thing to consider when shopping for a new loan. However, the general rule of thumb is that if you can get an interest rate at least two percentage points lower than what you are currently paying, refinancing should pay for itself.
So, take out a piece of paper and figure out:
1) your current monthly payment,
2) the original cost of the home;
3) an itemization of refinancing costs,
4) your monthly payment after the refinance,
5) the length of time you plan to live in the house after the refinance,
6) the amount still owed on the house, and
7) the break-even point (calculate this by dividing the total cost of the refinance by how much you’ll save each month on your payment; for example: $2000 cost of refinance divided by $100 per month savings equals 20 months).
Depending on your ultimate goal in refinancing, the above numbers should give you a good idea of whether or not it makes sense. If it still looks like a jumble to you, there are many online “calculators” that can assist you in figuring out the pros and cons of refinancing: www.reficenter.com and www.smartmoney.com for example. Or, you can talk to your mortgage professional for further clarification. Don't have someone? I would be happy to recommend you to some great mortgage lenders who could help you!
So, in summary…
If you want to refinance, it’s a good idea to think and plan carefully before you do so. Don't do it just because everyone might be talking about it.
First rule: if you plan to pull out cash from your refinance to pay off credit card debt, REALLY make sure you don’t run them up again! It might be a good idea to close those cards you do pay off so you are not tempted.
If you’re pulling out cash to make home improvements, do them right away. It is very easy to spend money put aside for something without realizing it, and to adjust to a higher standard of living — even a temporary one. Plus, you will quickly realize the benefit of refinancing and get to enjoy those home improvements longer!
And if you are pulling out cash for any reason, consider NOT pulling out the maximum. Leave some equity in place for your security, to ensure a lower house payment, or in case of emergency.
Refinancing can be an incredibly smart decision that saves you a lot of money. But, it’s up to you to do the homework and decide if it makes sense for you. And don't forget that there are always professionals who are here to help you figure it out! You are welcome to reach out to me anytime for my list of recommended lenders!