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Personal finance is often complicated, and mortgage topics can be some of the most involved. Sometime after you've completed your mortgage paperwork, you still may wish to consider refinancing. Simply stated, when you refinance your mortgage, you take out a new loan that replaces your original mortgage. The new loan pays off your original mortgage and comes with its own loan terms, different from your original loan.
There are a number of reasons you may benefit from refinancing at some point. Some of the most common reasons include:
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Locking in a lower interest rate
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Eliminating private mortgage insurance (PMI)
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Lowering your monthly payment
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Cashing out home equity to use the money for other purposes
If you think refinancing might be an attractive option for you, here are some questions to consider.
1. How have interest rates changed since my mortgage was issued?
If mortgage rates now are lower than they were when your mortgage was issued, you could take advantage and refinance to a lower rate loan. The lower rate could decrease your monthly payment and provide long-term interest savings.
2. Has my credit improved since my mortgage was issued?
If your credit score has improved since the time you received your mortgage, you may qualify for a better mortgage interest rate. Just like the refinance benefits you'd see if interest rates decreased overall, a refinance due to better credit could provide savings on monthly payments and significant savings on interest in the long run.
Related reading: A 10-Step Guide to Improving Your Credit Score
3. Would I benefit from changing my loan type?
Since different types of mortgages include different repayment schedules and details, your mortgage type affects how a refinance would work for you. For example, say you have an adjustable rate mortgage (often called an ARM). With an ARM, the initial interest rate will change—and possibly increase—after a certain amount of time, such as five years. If you have an adjustable rate mortgage that is scheduled to raise its rate, you may benefit from refinancing to a standard fixed-rate mortgage that allows you to lock in a rate for the life of the loan. Changing loan terms in this way is one common reason to refinance.
4. What will I pay to refinance?
Just like when you took out your original mortgage, you'll pay fees to refinance. Ask your loan officer to help you figure out whether the savings you realize from a refinance will allow you to recoup the following costs during the time you expect to own your home:
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Application fee
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Closing costs (approximately 3–6% of the loan amount)
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Title insurance and title search fees
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Appraisal fee
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Attorney and preparation fees
5. How will my monthly payment change?
Your loan officer can provide you with information on what your new monthly payment would be if you refinanced. As we've discussed, you may reduce your monthly payment if your new interest rate is lower. Also, if you've reached 20% equity in your home and are therefore able to eliminate paying private mortgage insurance (PMI), your monthly payment would be reduced. You must weigh these monthly savings against the fees involved in refinancing.
6. How long do I intend to own this home?
While we can't predict the future, you should make an educated guess as to how long you intend to own your home before you decide to refinance. First of all, you must ensure you will be there long enough for your new monthly payment savings to offset the costs of refinancing, as we discussed above. Your loan officer can help you with those calculations. Also, the length of time you think you'll stay should affect your choice of mortgage loan. For example, if you think you'll sell your home in about five years and could refinance to an adjustable rate mortgage that offers a lower rate for the first five years, refinancing might be a great plan. On the other hand, if you think you'll sell next year, any monthly savings are unlikely to offset the fees you'd pay to refinance.
7. How long have I been paying on my existing mortgage?
As you may know, as you repay a mortgage loan, your payments direct more money toward interest first, and you pay down principal (the actual loan amount) gradually over time. With every payment you make on your mortgage, you pay more toward principal and less in interest than you did the month before. This timing is an important consideration when thinking about refinancing because if you refinance, you start over with a new loan.
As an example, let's say you're 15 years into a 30-year fixed-rate loan. At that point, you're likely directing over half of each month's payment toward principal and making real progress toward paying off your loan. If you were to refinance at the halfway point, you'd start over, with your new payments going mostly to interest instead of principal again. Since your ultimate goal is to pay off the principal, refinancing is less likely to make financial sense when you're many years into your loan term.
While the decision to refinance can be complicated, a refinance can provide great benefits in some situations, but it's important to consult your loan officer before you make any decisions.
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