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- Refinancing a mortgage can be a good way to lock in a lower rate or tap into your home equity.
- But depending on your circumstances, you may decide it isn't worth paying the closing costs.
- To decide whether you should refinance, consider your goals and use a refinance calculator.
Refinancing your mortgage can be a great way to save money, both in the short-term and long-term. You can swap out your current mortgage for one with a different term length, lower mortgage rate, and even lower monthly payments.
Refinancing isn't always a good idea, though. It depends on your current financial situation and your goals, in addition to current mortgage rates.
Should I refinance my mortgage now?
Interest in refinancing has dropped sharply as mortgage rates have risen. Compared to the refinance boom in Q3 of 2020, the dollar volume of refinance applications has fallen nearly 90%, according to Fannie Mae's Refinance Application-Level Index.
Now probably isn't a good time for you to refinance your mortgage, since most borrowers have mortgage rates that are near or lower than current average rates. But most major forecasts expect that mortgage rates will start to drop toward the end of 2023 and throughout the next couple of years. This means that if you're interested in refinancing, you'll likely have an opportunity to do so soon.
When to refinance your mortgage
You have an adjustable-rate mortgage
Adjustable-rate mortgages keep your rate the same for the first few years, then change it periodically, usually once per year.
When ARM rates start lower than fixed rates for the introductory rate period, they can help homeowners who plan to move or refinance before the rate changes save money. Plus, there's always the chance your rate could decrease later.
But an ARM might not be the best option at the moment, since ARM rates are starting near or even higher than fixed rates in many cases.
If you're coming to the end of your ARM intro period and plan to stay in the home for a while longer, you may want to refinance into a fixed-rate mortgage, which will keep your rate the same until your final payment.
You could get a significantly lower rate
Depending on when you got your mortgage, refinancing could help you get a lower rate, lowering your monthly payment.
In general, you should only consider refinancing if you can reduce your rate by a full percentage point or more. Otherwise the cost of refinancing might ultimately not be worth it.
Currently, mortgage rates are relatively high, meaning it's unlikely you'd see significant savings by refinancing. But as rates drop in the coming years, refinancing may start to look more attractive.
You want a new loan term
Maybe you want to refinance into either a shorter term or longer term.
Let's say you have 20 years left on your mortgage, and you refinance into a 15-year term. You'll pay off your mortgage five years earlier and save a ton in interest.
Or you have 20 years left on your mortgage and refinance into a 30-year term. By spreading out your payments over a longer period of time, your monthly payments will go down.
Whichever option you choose, just be aware of the pros and cons. Refinancing into a shorter term saves you money in the long run, but your monthly payments will be higher. Refinancing into a longer term lowers your monthly payments, but you'll pay more in interest over the years.
You need to consolidate debt
If you've gained equity in your home since buying it, you might want to do a cash-out refinance. With this type of mortgage, you take out a loan larger than the amount you still owe, and you receive a portion of your home's gained value in cash.
Using the equity in your home to pay off your other debts can be a smart financial move since mortgages typically have lower rates than other types of loans, which saves you money in the long run. Just be sure to weigh the benefits of this against any closing costs you'll pay and the risk of tying additional debts to your home.
You want to complete home renovations or repairs
A cash-out refinance can also be a useful tool if you want to put some money back into your home with an upgrade or repair. The money from a cash-out refinance can be used to replace your roof, remodel your kitchen, or fund other value-boosting renovations.
Your credit score has improved
If your credit score wasn't great when you initially got your mortgage but has since improved significantly, refinancing could help you snag a lower rate.
Keep in mind, though, that there are many factors that go into determining your interest rate on your mortgage. While your credit score is a big one, general market trends are important to consider, too. If average rates were significantly lower when you got your current mortgage, you probably won't be able to get a better rate now, even with an excellent credit score. But if average rates are similar to when you got your current mortgage, a refinance could be worth it.
When it might not be a good idea to refinance
It would take a long time to break even
Just as with your initial mortgage, you have to pay closing costs when you refinance. According to the Federal Reserve, closing costs typically come to 3% to 6% of your outstanding mortgage balance. So if you refinance into a mortgage with a $100,000 principal, you'd pay $3,000 to $6,000 at closing.
Refinancing for a lower rate can be great, but how long will it take for you to save enough money to recoup your closing costs?
Darrin English, senior community development loan officer at Quontic Bank, told Insider the rule of thumb is that you should only refinance if your new rate will be at least 1% less than what you're paying now. Another way of looking at it is that you should be able to break even within 2 1/2 years.
"This was actually a Housing and Urban Development rule at one point, and it's become the standard," English said. "I've been in the business for almost 25 years now, so I just hold it as true, because I've seen success."
Think about the timeline you're comfortable with, though. You may decide you're fine if it takes longer to break even, because you plan to stay in this house forever.
You would use a cash-out refinance for unnecessary expenses
There are no rules about how you can use money from a cash-out refinance. But because refinancing comes with thousands of dollars in closing costs, it's probably not financially prudent to refinance to cover frivolous expenses.
Ultimately, it's up to you which expenses are worth doing a cash-out refinance. Just be sure to weigh the pros and cons before you move forward.
How to decide if you should refinance
Think about your financial goals
Ask yourself why you want to refinance right now.
Do you plan to pay off your mortgage faster? Save in interest over the years? Lock in lower monthly payments?
If a refinance can help you meet your goals, you might choose to go for it. But keep in mind that it might not be the only way to achieve your goals.
For example, you don't necessarily have to refinance just to pay your mortgage off faster; you could also make a lump sum payment and have your mortgage recast, lowering your monthly payment. Or you could make additional payments regularly to pay your mortgage off early.
Look at interest rates
How are interest rates now compared to what you're paying on your initial mortgage? If rates are significantly lower, you may decide it's time to refinance.
Shop around for lenders to find ones offering the best rates. You can also apply for preapproval with multiple companies to compare more personalized rates.
Consider closing costs
When searching for the right lender, ask each one for an itemized list of fees. This way, you can see how much you'll pay in closing costs with every company.
If you find a lender with a great rate and relatively low closing costs, you may have found your fit.
Take stock of your finances
Ideally, you'd be in a good financial situation when you refinance, for two reasons.
First, lenders reward people with stronger financial profiles with better interest rates. If you have a good credit score, low debt-to-income ratio, and a hefty chunk of equity in your home, you could get a great rate. But if you're lacking in these areas, you probably won't get the rate you're hoping for.
Consider beefing up your finances before refinancing, if necessary. Be sure to make all your payments on time to boost your credit score, or aggressively pay down some debts.
Second, you want to make sure you can afford the closing costs. You don't need to take on a financial burden you aren't ready for.
Use a refinance calculator
Want to figure out how much you'd save by refinancing? Try using an online mortgage calculator to see what your new monthly payments would be and how much you could save in interest. Seeing the numbers can help you make a decision.