Whether it’s a phone call at an inopportune time or getting letters in the mail, any time mortgage rates begin to drop, you start to get notices about refinancing your home for a better rate.
There’s a lot of thought that should go into the idea of refinancing your home. Like anything else, refinancing has its good and bad points.
To decide if refinancing is the right option for you, here’s everything you need to know about refinancing your home loan.
Refinancing 101
There are myriad motives for refinancing your home mortgage, but the most common reasons to refinance include:
- Lowering your interest rate, which will lower your monthly payment
- Reducing the length of your mortgage to save thousands of dollars in interest
- Using your equity for home improvements or other large expenses
- When interest rates are low, locking in a constant interest rate if you have an adjustable-rate mortgage (ARM)
- When rates are high, converting to an ARM to lower monthly payments
- If your mortgage has a balloon provision with no conversion option
- For debt consolidation
Refinancing for debt consolidation can be tricky, so before you refinance for this reason, be sure to talk with a financial advisor. Loans that can be consolidated may include second mortgages, credit lines, student loans, and/or credit cards.
A key point to remember when deciding whether to refinance is how much it will cost. The process is very similar to when you purchased your home and will require an application, credit check, and title search. If you’re approved, you will still need to cover bank fees, appraisal and inspection fees, legal fees, points, and closing costs, just like the first time around.
How to Calculate Your Savings
Since it is not cheap to go through the refinance process, it’s important to make sure that the new rate is going to help you save money. A general rule of thumb is to aim for a rate that is at least two percentage points lower than your current rate.
Write the following out on a piece of paper to estimate the savings of your refinance:
1) Your current monthly payment
2) The original cost of the home
3) An itemization of refinancing costs
4) Monthly payment after refinancing
5) The length of time you plan to stay in the home after refinancing
6) The payoff amount
7) The break-even point (calculate this by dividing the total cost of the refinance by how much you’ll save each month on your payment; for example, the $2000 cost of refinancing divided by the $100 per month savings equals 20 months).
Depending on your ultimate goal in refinancing, the above numbers should give you a good idea of whether or not it makes sense. If you still need additional help, here are two refinancing calculators to check out: www.reficenter.com and www.smartmoney.com.
Plan Carefully
If you want to refinance, it’s a good idea to think and plan carefully before you do so. Many homeowners who refinance their homes do so to use the equity in their homes. If you plan to do a cash-back refinance, here are a few things to keep in mind.
When using equity to pay off a credit card, be sure to close the credit account as well. By closing the account, you’re less likely to get a replacement card and start using it again as opposed to just cutting the card up.
Any equity going toward home improvements should be budgeted and made as quickly as possible. Have a game plan in place for the renovations before moving the money into your account; that way, you don’t spend the money on unnecessary items.
Lastly, don’t use all of the equity you have built up in your home in a cash-out refinance. If things change and you have to move before you planned to, this will be a buffer to keep you from having to bring money to the closing table.
Refinancing can be a boom — or a bust. It’s up to you to do the homework and decide if it makes sense for you.