By committing to a mortgage with lower interest rates, you can also lower your monthly payments. Over time, even saving $50 a month can add up to thousands over the life of the loan.
Still, there are pros and cons to refinancing, and you should be familiar with the costs and benefits before making adjustments to your existing mortgage. Below is a guide to help you decide whether refinancing your home is the right choice for you and your household.
Why would consumers choose to refinance?
There are a number of reasons why homebuyers choose to refinance their homes. They include:
- Lower interest rate. By refinancing, consumers have the opportunity to lower their mortgage interest rates. If your credit has improved since your initial home mortgage, or if market interest rates have fallen in that time period, you may be able to get a mortgage with a lower interest rate during the refinancing process.
- Cut monthly payments. By lowering your interest rate through a home refinancing, you can also lower your monthly mortgage payments. Monthly payments are directly correlated with your home loan’s interest rates, so when you are able to adjust your interest rates lower, you’ll also save money each month.
- Adjusting length of mortgage term. When refinancing a home, you can also opt to adjust the length of the mortgage term, either by increasing or decreasing it. For example, you can switch from a 30-year mortgage to a 15-year mortgage or vice versa. By adjusting to a longer mortgage, you’ll reduce your monthly payments. However, by prolonging the life of the loan, you’ll ultimately pay more for the total cost of your loan as interest rates add up over time. You can also choose to decrease the term of your mortgage. By changing from a 30-year loan to a 15-year loan, you will increase your monthly payments, but you’ll pay off the loan more quickly, thus reducing the interest costs over the course of the loan.
- Change from adjustable-rate mortgage (ARM) to fixed-rate. You may be able to switch from an ARM to a fixed-rate mortgage when refinancing. With ARMs, mortgage payments change periodically as market interest rates shift. When refinancing, you can change from an ARM to a fixed-rate mortgage, giving you a more stable, locked-in payment plan.
Refinancing as rates are rising
Mortgage rates are not stagnant. They fluctuate over time, sometimes sharply. If you purchased a home during a time when mortgage rates were higher than they are currently, you can lower that interest through a successful refinancing.
Mortgage rates were on the rise throughout 2018 and have been predicted to remain the same or move higher in 2019. With market uncertainties ahead as rates possibly hit a high of 5.8% this year, you’ll need to look closely at refinancing your mortgage.
If you entered a mortgage agreement with a lower interest rate than those in the current market, refinancing may not be right for you unless you’re opting to change the length of the mortgage term. On the other hand, if you currently have an ARM and are worried interest rates will continue to rise, you may consider refinancing in 2019.
Determine if the mortgage is affordable
Unfortunately, refinancing isn’t free. You may find yourself already familiar with some of the costs associated with refinancing, as they are similar to the ones you encountered when first taking out a mortgage. You may have to pay loan-origination fees, points on the principal, closing fees, appraisal and inspection fees, attorney fees and others.
Be prepared to pay between 3% to 6% of the remaining principal during the course of refinancing a home to pay for the above expenses, as well as any prepayment penalties you may incur from your lender.
These fees may cancel out the savings you would incur by refinancing your home.
Calculate potential savings from refinancing
Doing the math to see whether fees and other associated costs add up to more than the savings will help you see if you could benefit from when you refinance a home. You may find that it’s better to pay off your mortgage quicker by increasing your monthly payments rather than entering a refinancing agreement.
If your main goal with a refinancing is to shorten the term of your loan, you may be able to do so by paying more toward your principal each month. Even increasing monthly payments by $50 each month can add up to thousands saved in interest costs and reduce the life of your loan by a few years.
When deciding whether to carry out a home refinancing, tally up the costs, any penalties and other fees to calculate the break-even point for your new loan. Before entering a new loan agreement, you can estimate how long it will take you to break even between refinancing costs and your new, lower mortgage rate.
Cash-out refinancing vs. traditional refinancing
There are a few different ways to refinance your home. Namely, there are the options for a cash-out refinance or a traditional refinancing.
- Cash-out refinance. A cash-out refinance allows you to replace your current mortgage with a new mortgage worth more than you now owe on your existing loan. You can then take the remaining difference out in cash. Homeowners often use this cash to pay for home improvements or to pay for a child’s education. If you’re seeking such a loan, be cautious — many advisers counsel against using the cash-out refinance to pay off credit card, car loans and other unsecured or short-term debt.
- Traditional refinance. A traditional refinancing is centered on replacing an existing mortgage with a new one. Homeowners may consider a traditional refinancing to reduce interest rates and monthly payments, as well as to decrease or increase the course of the loan term.
Getting the best rates
Shop around for lenders to get the best rates when refinancing a home. Keep your eyes on the market to see how mortgage interest rates are trending in order to land the best rate. Also, shop around for a lender that offers lock-in rates, which is a lender’s commitment to maintain the terms of a specific interest rate while your refinancing application is being processed. Lenders may charge you a flat lock-in fee.
You can also increase your chances of refinancing with a new, improved mortgage interest rate by focusing on the state of your other personal finances, particularly your credit score. You may be eligible for better interest rates or lower monthly payments if you’ve improved your credit score since you entered your initial mortgage agreement.
It’s also possible to negotiate closing costs, including the cost of a title search and title insurance. If you have insured your home’s title within the last 10 years, you may be eligible for a discount. Ask the lender holding your title insurance policy if it can reissue your policy, rather than conducting a brand-new title search again, and you may be able to save on these costs.
There’s no foolproof way to predict the state of the housing market; as such, you can expect mortgage interest-rate fluctuations every year.
The same is true for 2019, which is why you’ll need to consider refinancing with care. Evaluate why you want to refinance, whether it’s to shorten the life of the loan, decrease monthly payments or to move from an ARM to a fixed-rate mortgage.
Be sure to calculate the costs saved versus expenses that arise during the loan process, keep your eye on the loan markets and make sure to find the best possible rate for yourself when exploring refinancing your home.