When You Should (And Should Not) Refinance Your Mortgage

Posted by Chris on September 30, 2015

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Interest rates have been at their lowest in decades for several years and despite fears of interest hikes and hyperinflation, it hasn’t happened. So if you’re getting anxious to secure a lower interest rate, pay attention!

First things first, before you start shopping for lenders, you have to figure out what your goals are. Are you trying to lower your current interest rate on your mortgage? Want to consolidate multiple mortgages or other debts? Need to change the terms of your loan? Or, maybe you want cash for a major purchase or renovation?

Determining your goals can help you decide whether you’re a good candidate for refinancing – and if it makes sense for you to try to refinance now. Below, we’ll walk you through a few different scenarios and the considerations you should make to determine if refinancing is right for you.

Scenario #1: You Want to Lower Your Interest Rate

If you are refinancing with the goal of lowering your interest rate, many industry experts believe you should not refinance unless the interest rate is at least 2% below your current mortgage rate. This rule was more important when interest rates were higher. Because rates have been great for some time now, a 2% drop is extremely unlikely at this point. That said, it’s best to weigh the costs of refinancing against the expected savings to determine if it’s really the right time for you.

This article by our friends at LifeHacker offers some more tips for determining if the benefits outweigh the costs.

Scenario #2: You want to Consolidate Your Debts

If you have more than one mortgage or a mortgage plus an equity line of credit, consolidating those into one loan is a good reason to finance. You can lock in the same interest rate for all of your loans and level out your monthly payments.

The Mortgage Professor offers some great insights on debt consolidation. While this article was written back in 2011, the main ideas remain true.

Scenario #3: You’re Underwater on Your Mortgage

If you are underwater on your mortgage, you should take advantage of refinance programs that can help you. HARP is one program that is offered by the Federal government that will allow you to reduce your monthly payments and stay in your home even if you have bad credit.

There are some very specific requirements that must be met to be eligible for this program, and the folks at Smart On Money recently wrote a blog that can help you understand those specific details.

Scenario #4: You’d Like to Change the Term of Your Loan

If you are paying a high monthly mortgage and still have 20 years left on your loan, you can refinance to push it out to a 30-year loan and reduce your monthly payments. Likewise, you could refinance to shorten the term of your loan from a 30-year mortgage into a 20 or 15-year mortgage to pay it off sooner.

In addition, you can change the type of loan you have from an adjustable rate mortgage (ARM) to a fixed-rate mortgage and vice versa.

If you can afford to pay a higher monthly payment and you are anxious to pay off your loan, refinancing can help. With interest rates so low, you can shorten the term of your loan while only increasing your monthly payment slightly.

Investopedia uses this example: You refinance your $100K 30-year fixed rate mortgage from an interest rate of 9% down to 5.5% over 15 years. They calculate that your monthly payment would only increase by $13! Still, don’t forget to factor in closing costs and other fees.

Scenario #5: You’re Thinking About Taking Out Equity from Your Home

If you want to make a major purchase or make home improvements, you can refinance to withdraw some of the equity you have built up in your home. Keep in mind that taking out equity will increase your debt and extend the length of your loan. If you plan on moving within five years of refinancing, this may be a bad move for you.

Cash-Out Refinancing vs. Standard Refinancing

If you still think refinancing may be for you, it’s important to remember that refinancing falls into two main categories: one to take cash out of the equity in your home and one to restructure your payments.

Cash-Out Refinance: You have a major medical emergency, you are putting one of your kids or grandkids through college, or you just need help with everyday expenses, you may want to choose this option.

Say your current mortgage is $300K. If you do a cash-out refinance for $20K, you will replace your original mortgage with one for $320K to cover your original loan plus the $20K cash you are taking out of the home.

Standard Refinance: To lower your interest rate or to change the terms of your loan you will choose a standard refinance. You do not take out cash unless you add the amount that you have to pay in closing costs and other fees to the amount of your new mortgage.

It typically costs less for a standard refinance than a cash-out refinance and the interest rate is lower. You won’t be adding another $20K in debt either…just a few thousand more in interest paid out over the term of the loan.

What does it Cost to Refinance?

Many people forget that refinancing can put some extra money in your pocket, but it will also cost you. There are many upfront costs as well as back-end costs associated with refinancing. Most lenders will require application fees, an appraisal, origination fees, private mortgage insurance and title insurance. It’s estimated that refinancing with some lenders can cost as much as 6% of the amount of your loan.

U.S. Bank estimates that on a home loan of $200K, your closing costs will typically be close to $2,500. That does not include any taxes that you will have to pay or insurance. They also caution that the amount of your closing costs is dependent on your credit score. A less than stellar credit score may cost a lot more.

One More Thing …

If you have a high loan-to-value ratio or LTV ratio (borrowing 80% or more of the value of your home) your upfront costs may be higher. The cost to borrow could be higher and/or you may be required to purchase private mortgage insurance.

Speak with a professional to understand your unique situation!

You can use our handy refinance calculator to find out what kind of savings you could get from refinancing. And, you may want to find out how healthy your credit is too by requesting a free copy of your credit report. You can also use a service like Credit Karma to see your credit score for free. In the meantime, be sure to connect with a member of our team at Lenda to determine if refinancing makes sense for you.

Lenda clients save an average of $409 per month on their mortgage payment. We’re ready to shake up the mortgage industry and help you enjoy the benefits. Connect today!

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Topics: Mortgage 101, Refinancing

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