Mortgage refinances can be a huge benefit to your financial situation; if it’s worth it. Figuring out if a mortgage refinance is worth the process can be challenging. There are so many factors to consider! You must think strategically about this. There are a few things you will want to think about when deciding whether or not you should get a mortgage refinance.
Reasons to Get a Mortgage Refinance
A good rule of thumb is to think about your mortgage refinance in terms of your money. Your financial situation will be a good guide when deciding if you should refinance. Oftentimes people like to consider a refinance if they want to have a lower payment, save on interest, or get cash out of their home. There are some other reasons to get a refinance that you should think about before you begin the refinance process.
Mortgage Rates Decreased
Mortgage rates are constantly changing due to the impact that a variety of factors have. Some of these factors include the economy, inflation, market movements, Federal Reserve monetary policy, global factors, and more. Sometimes mortgage rates can decrease to below the point they were at when you signed your mortgage. If that’s the case, you may be able to save money by getting a lower interest rate than the one you currently have. However, you need to be aware of how low rates should be to consider a refinance. The general rule of thumb is to refinance if the current rate is 1% to 2% lower. However, that doesn’t need to be the case. It may make sense for you to refinance between .5% and 1% as well. You want to keep the point you break even in mind.
Should You Refinance for 0.5%?
You may be able to consider a refinance for 0.5% in certain situations. If you keep the new loan long enough to bounce back from the closing costs or if you can persuade the lender to take care of your closing costs you may be able to consider this mortgage rate as a viable option. It is important to keep in mind that when you refinance for just a 0.5% rate you get less savings compared to refinancing at a higher rate. That means it will take more time to recover from the closing costs of the refinance.
It is best to see this in numbers. For example, dropping your rate from 3.75% to 3.25% could save you $150 per month on a $300,000 home loan, according to Mortgage Reports.
While that savings may sound nice – it will take a little over three years to reach your break even point when you account for closing costs. Which means the refinance will only be worth it if you stay in the home for at least 4 years. Now compare that to a refinance for 1%.
Should You Refinance for 1%?
The general rule of thumb is to refinance for between 1% and 2%. While some are eager to refinance for less, it may make more sense to go with the usual rates. For example, dropping your rate from 3.75% to 2.75% could save you $300 a month on a $300,000 loan. You would be saving double compared to a 0.5% refinance. Instead of reaching the break even point in 3.3 years, you could reach it sooner. In fact, you could roughly reach your break even point in as little as just over a year.
Your Credit Score Increased
The better credit score you have then the better interest rate you’ll get. That is why it is important to always work on improving your score. There are many factors that impact your credit. Your usage, hard inquiries, age of credit, lines of credit, and more have an impact. You will need a minimum score of 620 for a typical mortgage refinance, but can have a score as low as 580 for some government programs. These scores are considered “fair” according to FICO Credit scoring. Now imagine what your interest rate would look like if you increase your score. You still have opportunities to improve your credit to good, very good, or even exceptional. You will see your improved credit score translate to a more affordable interest rate. This new and improved interest rate can mean hundreds or even thousands of dollars in savings in the long run.
Update Your Loan Terms for your Monthly Payment
A mortgage refinance is a great opportunity for you to update your loan terms to change your monthly payment. You can opt to increase the length of your loan in order to reduce your monthly payment. On the other hand, you could shorten the length of your loan in order to pay the debt off faster even though you will have a higher monthly payment. Either way, a refinance can provide you the opportunity to change your loan terms to better fit your financial goals.
The Value of Your Home Went Up
Your home’s value has the potential to increase. If your home’s value went up then it may be especially beneficial for you to refinance. You can consider a cash-out refinance to get cash out of your home. This is a type of refinancing option that allows the borrower to take out a larger amount than what was owed on the original mortgage. The difference is provided to the borrower in the form of cash. People also often consider cash-out refinances as another option to a home equity loan.
Change Your Interest Rate Terms
There are two different interest rate terms that you can choose from. Either an adjustable rate mortgage (ARM) or a fixed-rate mortgage. In an ARM, your interest rate is never guaranteed and can constantly change. A fixed-rate mortgage is a different story. You lock in your interest rate and that will remain consistent for the duration of the loan. People often like to get a mortgage refinance to change their interest rate terms to improve their budgeting. When you have a fixed interest rate, it is easier to account for costs that you will have every month. You can better budget and enhance your overall financial situation with proper management compared to an ARM interest rate.
Is It Worth It to Refinance a Home Mortgage?
Finding the right time to refinance your mortgage can be tricky. There are times that you may want to avoid refinancing your mortgage.
- Prepayment Penalty: Sometimes people have a prepayment penalty on their mortgage. That will need to be accounted for when making a decision. You will need to prepare for any more costs like dealing with penalty fees.
- Home Equity Loan: If you already have a home equity line of credit (HELOC) or home equity loan then you may need to repay that before you can refinance. That is because you will have to ask the lender for permission to refinance your loan. If they deny your request, you may have to pay down the balance first.
Calculating Your Break Even Point
This is a key part in deciding if refinancing is a good decision for you. This shows you how long it will take for the refinance to be worth it in the long run. To figure it out, you need to divide your mortgage closing costs by your new mortgage savings every month. If you aren’t in the home long enough to reach this point, then it may not be worth it to refinance right now.
Don’t Forget About Refinance Fees
Unfortunately, refinances aren’t a free ride. In fact, they can actually be pretty pricey. Some fees you may encounter are application fees, appraisal fees, origination fees, and closing costs. You want to account for this when deciding if refinancing your mortgage makes sense.
Do You Have Patience?
The refinance process usually takes anywhere from 30 days to 45 days. However it can be longer or shorter than that depending on your specific refinance. You will need to put in time and effort to get a refinance done. You want to make sure you are ready to dedicate what you need when you refinance your mortgage.
When Shouldn’t You Refinance Your Mortgage
Just as there are reasons to refinance your home, there are reasons that you shouldn’t. It is also important to make sure that you have the right intentions when you refinance your mortgage. In fact, there are quite a few bad reasons to get a mortgage refinance. There can be some downsides associated with refinancing your home.
People sometimes consider a mortgage refinance to be an option when it comes to debt consolidation. Debt consolidation must be managed properly or it can end up ruining your financial standing. While at first it may seem like a good idea to pay off your current high interest debt with a low interest mortgage, it has some key components.
You need to keep in mind the fact that you are transferring an unsecured debt like credit debt into a debt that is now tied to collateral. If you were unable to pay off your unsecured debt, you didn’t run the risk of losing anything like a car or a home. A collateral loan is a different story. In this set up, if you do not pay what you owe then you will lose something as collateral. In this case it would be the home now.
Get a Longer Loan
You should only consider getting a longer-term loan if it financially makes sense. However there are instances where it wouldn’t make sense. If you only have 5 years left on your mortgage and decide to stretch the remainder of the payments over the course of 30 years with your refinance then that wouldn’t make sense. You would end up paying more with just your interest rate by the end of the loan and have 25 more years of payments.
Save Money for a New House
Moving soon? Then you want to make sure the numbers make sense in your refinance. If your goal is to use the refinance to save money for a new house, you need to be aware of the calculations. If your break even point is after 4 years but you plan on moving in 2 years then you shouldn’t get a mortgage refinance. It may feel like you are saving with lower monthly payments but it doesn’t matter until you reach that point where you break even. You need to look at the overall picture.
Use the Money from Your Cash Out Refinance to Invest
Unless you are an expert investor then you should steer clear of this. The stock market is never guaranteed. If you try to count on using your cash out refinance money as a source of investment funds then you may be in over your head. You need to make sure you understand what investing entails before making a big financial decision like that. You may be better off using your money in different ways like to build an emergency fund.
How Frequently Can You Get a Mortgage Refinance?
There is no official limit to how often you can refinance, but lenders usually have their own guidelines. Some lenders even impose prepayment penalties on their loans. You can gauge how often you can refinance your home by looking at your financial situation. You need to be able to have enough equity, a good enough credit score, as well as other eligibility requirements. You also need to make sure you can handle the costs and reach the point you break even. A refinance is likely not worth it until you reach that mark. However, there are other factors to consider as well.
Commonly Asked Questions
Understanding your home refinance can be a lot to deal with. That is why there may be some questions you have that others have asked as well. Some commonly asked questions are:
Will the Savings Be Enough to Make Refinancing Worthwhile?
That varies from person to person. You need to figure out the point where you break even in order to determine whether or not your refinance is worthwhile. You can calculate your break even point by dividing your mortgage closing costs by your new mortgage savings every month.
Why Refinancing is a Bad Idea?
Refinancing can be a bad idea if you do not properly manage the process. There are a lot of aspects to keep in mind when deciding if it is a good time for a mortgage refinance. Calculating the point you break even, and considering your financial situation can greatly improve your chances of having a successful refinance. You should not get a refinance if it doesn’t make sense to do so. That is the worst idea you could pursue!
When is Refinancing a Mortgage Worth It?
Everyone has their own idea as to what makes a mortgage refinance worth it. Generally, you want to try to reach the point where your refinance “pays for itself”. This means aiming to get past that point where you break even. When you get to that point then you can reap only benefits from your refinance and make it worth it overall.
What are Mortgage Refinance Options?
There are a variety of refinance options available. However, the two popular ones are:
- Rate-and-Term Refinances: Rate in this refinance title refers to the mortgage rate percentage that you pay in interest on the loan. Term refers to the mortgage term which is how long the borrower has to repay the loan. A rate-and-term refinance changes these aspects of the loan specifically.
- Cash-Out Refinance: This is the refinance that was mentioned above. This type of refinance allows borrowers to borrow more than what the original home loan is worth.
You can discuss what available refinancing options are available with your lender. Every financial institution is different. That is why it is important to specifically see what your lender offers. Have your lender explain the pros and cons to each refinancing option as well.
What Factors Do Lenders Look At?
Each lender has their own eligibility criteria for a mortgage refinance. Factors like your credit score, home equity, and debt-to-income (DTI) ratio will all likely play a factor in their decision. Your credit score verifies your credibility with the lender as a good borrower; your home equity shows the lender how much you currently own of your home; your DTI shows lenders the likelihood of you missing a mortgage payment. Those with high DTI rates have a higher chance of missing a payment.
Understanding if a mortgage refinance is worthwhile depends on a bunch of factors. You want to look at mortgage rates, your credit score, your loan terms, the value of your home, prepayment penalties, closing costs, all fees, and more when making this decision. Each of these factors play a role. That is why it is also important to make sure you have a clear understanding of your goals with a mortgage refinance. Even if it feels like you should refinance due to benefits like a lower monthly payment or a shorter loan term, it still may not matter in the end. As long as you know why you want to get one and when your break even point will be, you can make an educated decision.