There are times when it makes sense to refinance your mortgage. It is however, important to have a clear financial objective in mind to be able to choose the most appropriate loan.
Since interest rates are at a 40-year low, switching to a lower rate may save you a lot of money – possibly thousands of dollars per year. There are penalties for paying your mortgage loan out prior to renewal, however these could be offset by the extra money you save through a refinance.
Before deciding whether or not to refinance, you need to determine what you want to accomplish. Remember, a refinance doesn't pay off the debt; it just restructures it, often at a lower interest rate and a different loan term than the current mortgage.
- Reducing the interest expense is the most common goal of a refinance. But some homeowners also appreciate the ability to extend the loan back out to 30 years, reducing the monthly payment.
- Debt consolidation is another goal of refinancing. If you have both a first mortgage and a home equity mortgage, combining the two mortgages into one fixed-rate mortgage levels out the payment over the loan term.
- Getting cash from your home. The equity you have in your home can act like a savings account that you could access through a home equity loan or a cash-out refinance. This is usually done when you want to finance an important home improvement, pay for college or pay off high-interest credit card debt. Whatever your reason, this may be the right option for you.
How Does Mortgage Refinancing Work?
When you choose to go with mortgage refinancing, you are effectively drawing a new loan to cover the old. With this new loan, you receive the updated terms that you agreed upon while talking with your lender. The updated terms can help reduce your monthly payment or decrease your interest rate by several points.
You do have to shop around to see where you can get the best rates. As you compare loan products, you can decide if you should refinance or if your existing loan is the better option. Once you find the mortgage refinance terms you prefer, the lender will process your paperwork and keep you informed of its status.
With approval of your refinance request, your lender will pay off your existing loan and apply the new loan amount to your account. Your monthly mortgage payment will reflect the terms in the new agreement from that moment forward.
When To Refinance
After determining your reasons for refinancing, you need to consider whether the timing and circumstances make this the right time to get a new mortgage.
You may be better off to stay with your current mortgage. For example if your current mortgage has a high prepayment penalty or if you plan to move from your home in the next few years or when the monthly savings gained from lower monthly payments may not exceed the costs of refinancing.
As a rule of thumb, it pays to refinance if you can get an interest rate at least two percentage points lower than what you are currently paying. Asking yourself a few questions may help you determine if you can save money:
- How much can I lower my current monthly payment?
- How long do I plan to stay in the house after I refinance?
- How much will I pay in refinancing costs?
How To Refinance
Refinancing is similar to the process you encountered when you closed on your first mortgage. It requires an application, credit check, new survey and title search, as well as an appraisal and inspection fees. As you know, this process can be quite lengthy and expensive.
Keep in mind, however, that by refinancing you may extend the time it will take to pay off your mortgage. That said, there are many ways to pay down your mortgage sooner to save you thousands of dollars. Most mortgage products, for instance, include prepayment privileges that enable you to pay up to 20% of the principal per calendar year. This will also help reduce your amortization period (the length of your mortgage), which in turn saves you money.