When Does It Make Sense To Refinance Your Mortgage?

When interest rates are low, there are a lot of people wondering if it makes sense to refinance their mortgage. But is it the right financial move for you? Last time interest rates dropped I was able to refinance and drop our interest rate. We wound up not only saving about $100 a month but will end up paying over $25,000 LESS in interest over the life of the loan! Let’s take a look at the reasons you might want to refinance and some considerations before doing so.

When Does It Make Sense To Refinance Your Mortgage?

It may make sense to refinance your mortgage if you want to:

Take advantage of low interest rates 

When the interest rate falls it’s one of the most common triggers to refinance. Lower rates usually mean lower payments.  For example, a 30-year mortgage for $200,000 at 4% would mean a monthly payment of $954.83 while decreasing the rate by only 1% would lower the payment to $843.21 saving more than $40,000 in interest over the life of the loan. Alternatively, you can continue paying the same amount as the original loan and pay off the new mortgage early and save on interest. You can take a look at how much a 1% difference makes on your monthly payments.

Replace an adjustable-rate mortgage (ARM)

Another great reason to refinance is if you are going to a fixed-rate loan from an adjustable-rate mortgage or ARM. An ARM is a loan that offers a great, low rate initially, then after a set amount of time, usually one to five years but sometimes longer, the rate becomes adjustable.

Get Cash Out of Equity

One of the perks of homeownership is building up equity. When times get tough, it is helpful to have the option to pull out some of that equity to help with any unexpected costs. The cash can help you pay off higher-rate debt or unforeseen medical bills, for example. 

Shorten the Term of Your Mortgage

There are many benefits of shortening the term of a mortgage. Shortening the term usually leads to a lower interest rate, since the mortgage company would have less risk. Depending on how much you shorten the term and lower the rate your overall payment may not necessarily be lower, but you could save thousands in interest. If you can fit that new payment into your budget, then you’ll be rewarded with not only reduced total interest but faster equity building as well. Take a look at an amortization calculator and compare the total interest paid for keeping your longer-term vs. shortening the term.

Eliminate Private Mortgage Insurance (PMI)  

Private mortgage insurance, also known as PMI, is a type of mortgage insurance you might be required to put on your loan if you have a conventional loan. PMI protects the lender, not you if you stop making payments on your loan. PMI may be required if a down payment is less than 20% or your loan-to-value or LTV is more than 80%. The cost of PMI is generally $30 to $70 per $100,000 of the principal loan amount. When mortgage rates are low, refinancing your mortgage may allow you to eliminate PMI if your new mortgage is below the 80% LTV threshold. This works best if your home has gained substantial value since the initial time you got your mortgage

Switch from a Government-Backed Loan to a Conventional Loan to Eliminate the Mortgage Insurance Premium (MIP)

Loans secured through the Federal Housing Authority (FHA) are required to have a mortgage insurance premium (MIP). Like PMI, MIP protects the lender and not the homeowner, in case the loan is defaulted on. If you are able to refinance your FHA loan to a conventional loan it may be possible to eliminate the MIP.

Combine Two Mortgages

If you have a second mortgage or a home equity line of credit (HELOC), which are usually higher interest rate loans you could combine the two into one lower payment and save on interest paid. This would act like a cash-out refinance (mentioned above), but because you are paying off a second property-secured loan, you would not be lowering the home’s equity.

Things to Consider for When Does It Make Sense To Refinance Your Mortgage?

While looking to see if it makes sense to refinance your mortgage consider the following things to make sure it is the right financial move.

Will you be Adding More Time to Pay off the Loan?

While refinancing to a lower rate could help you save money, you want to make sure to calculate the costs of extending your loan. If you have only 15 years to pay off your original 30-year term, consider the costs of refinancing to another 30-year term. You will, most likely, be spending more in interest over the life of the loan than you would have if you hadn’t refinanced. Using a refinancing calculator will help show you the whole picture. 

What are the Fees Associated with Refinancing?

The refinancing fees can, sometimes, outweigh the savings you receive from refinancing. Some companies charge an arm and a leg to process the applications. Make sure you are aware of the whole picture. Ask your refinancing company if there will be any or all of the following; origination, title, legal, home inspection, and/or appraisal fees. Also, make sure there aren’t any points attached to this refinance. Points, also known as discount points, is money that helps lower your final interest rate by charging an upfront fee at closing. 

Are you Getting Cash Out?

Consider the following; you are transferring unsecured debt into secure debt. If you can’t make your mortgage payments, you will possibly face foreclosure. While not paying back unsecured debt would just mean damage to your credit report. Which is, generally, less catastrophic than a foreclosure. Additionally, once they consolidate their debt, many borrowers fall into temptation and build those credit card balances up again. This may impact your ability to deduct mortgage interest. Please consult a tax advisor for more information. 

Do You Know the Whole Picture? 

Some people see that mortgage rates are low, get excited to lower their monthly payments, and jump at that chance. But without proper research, it could wind up costing more in the long run. Do your research on refinancing companies and do the math on the different options. There are many resources online to help you get an accurate look at the numbers. Make sure you read all the disclosures and make sure you understand all the costs involved. 

When interest rates are low, it may make sense to refinance your mortgage and, if done correctly, can potentially save you thousands of dollars and help build up the equity in your house quicker. There are several rules of thumb for home affordability. If refinancing helps bring you under those percentages by saving you money then it might make sense.

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