Many homeowners have taken advantage of historically low interest rates over the past few years to refinance their mortgages. If you aren’t among them, the talk of rising interest rates might be prompting you to consider whether you should refinance now. Refinancing your mortgage can have major benefits such as lowering your monthly payment and reducing the amount of interest you pay in the long run. However, refinancing to a lower rate isn’t always the best financial decision.
It makes sense to refinance when…
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You are planning to stay in your home long enough to offset the costs of refinancing: Just like with buying a home, refinancing comes with the additional expense of closing costs. Because you need to bring extra cash to the table (or finance the cost by rolling it into your mortgage), securing a lower interest rate won’t necessarily pay off if you plan to move in the near future. To determine your breakeven point, divide your total closing costs by the difference between your current monthly payment and your new payment after refinancing. This will tell you how many months you need to stay in your current home to offset the closing costs.
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You have an FHA loan and have built up at least 20% equity: One of the attractive benefits of an FHA loan is the ability to put down as little as 3.5%, but that does come with an extra monthly expense called private mortgage insurance (PMI). With a conventional mortgage, you can request that your PMI be dropped once you have 20% equity in your home. To get rid of PMI on an FHA loan, you must refinance. Depending on the value of your home, this could save you hundreds of dollars per month.
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You need to access equity in your home: If you were already planning to access equity in your home to pay off credit card debt or fund a home renovation, doing a cash-out refi could make the most sense if you can secure a lower interest rate. It’s a “two birds, one stone” scenario that gets you the cash you need and reduces the amount of interest you’ll pay on your mortgage in the long term.
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You need to lower your monthly payment: Refinancing to a lower interest rate won’t always save you money over the life of the loan, but it will likely reduce your monthly payment. If your budget is tight, this can make a big difference.
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Your credit score has dramatically increased: A substantial increase in your credit score could help you secure a better interest rate on your mortgage. To get the best rates, you should aim to have a credit score of 750 or higher.
It does not make sense to refinance when…
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The value of your home has declined to the point that you have less than 20% equity: If you go to refinance during a housing slump and your home is worth less than you paid for it, you may find yourself with less than 20% equity in your home. This means that a new mortgage would include private mortgage insurance, which could increase your monthly payment by a few hundred dollars.
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You think this new loan might be your last mortgage: This one is a little counterintuitive, but depending on how long you have left on your current mortgage, restarting the amortization process by refinancing might mean that you pay more in interest overall. If you fall in this camp, you should calculate the remaining interest you have left to pay and compare that to the amount that you would pay after the refi.
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Your credit profile has changed (and not for the better): Refinancing is similar to getting our initial mortgage in that you will be subject to the same standards when it comes to your “creditworthiness.” If you don’t have a steady income right now or have taken on other significant debt, you might not qualify for a refinance or may find yourself with less desirable terms than you were seeking.
Final Thoughts
While securing a lower interest rate is appealing, there are other factors to consider to ensure that you are making a good money move. Make sure you take your specific situation into an account and do the math to make sure it’s the right decision for you!
