The main reason that
most folks refinance a mortgage is to take advantage of a lower interest rate
and thereby end up with smaller monthly payments. But that's not the only
possible reason. You might refinance a 30-year loan into a 15-year one, ending
up with larger payments, but fewer of them and less total interest to pay.
Here's a review of these and other reasons to refinance your home loan.
Interest rates are
rising, so lock in a lower rate to save money everyone
knows that lower interest rates mean lower payments, but many people might not
realize just how much of a difference a lower rate can make. Check out the
table below, reflecting payments for various interest rates for a $200,000
30-year fixed-rate mortgage:
Bankrate.com, plus calculations by author.
you can lock in an interest rate that's a percentage point lower than what you
have, you may be able to save $40,000 or so over 30 years. (Note that when you
go through the pre-approval process opens
a New Window., you can probably find out exactly how much
you can save.)
credit score has improved
your credit score has improved considerably in recent years, you may now
qualify for a significantly lower mortgage interest rate -- even if overall
rates have been rising. Low credit scores keep home buyers from being offered great interest rates Opens a
New Window.. Check out the table below, which shows what
a difference a strong credit score can make, using the same mortgage example as
MyFICO.com, as of mid-February 2017.
you're currently carrying a mortgage at a high rate, consider spending the next
few months or the year ahead increasing your credit score so that you might
refinance at a lower rate. Some ways to Window. Include paying bills on
time and paying off a lot of debt in order to lower your
debt-to-available-credit ratio. Lenders like to see you owing only about 10% to
30% of the sum of all your credit limits, because it suggests that you have
your debt under control and can afford to take on some more debt via the
mortgage you're seeking. You can get Window. Of your credit reports once a
year from each of the main credit reporting agencies -- do so and correct any
errors on them.
might want a different kind of mortgage
Another good reason to
refinance is if a different kind of mortgage makes sense for you now. For
example, if you started out with an adjustable-rate mortgage (ARM), you may be
facing gradually increasing interest rates over the coming years -- which will
be costing you more and more. You could refinance into a fixed-rate loan,
locking in a low rate. (Even today's increased rates are historically very
might switch from a 30-year fixed-rate loan into a 15-year fixed-rate loan, in
order to pay the loan off sooner and pay much less in interest. It will likely
entail higher monthly payments, though, so be sure you can swing those. (A good
alternative is to keep the 30-year loan and just make extra payments regularly,
in order to shrink the principal.) If you’re current loan's monthly payments
are too steep for you (which might be the case if you have a 15-year mortgage
now), you might refinance into a fresh 30-year loan for the lower payments.
Just know that that will be costing you a lot in interest over the long run,
and entering retirement with mortgage payments is not ideal.
refinancing is not a great idea
There are some
situations in which refinancing doesn't make the most sense. For example:
If you don't think you'll stay in your home long
enough to recoup the closing costs for the refinancing (yes, there are closing
costs the process is very much like getting your initial mortgage), then don't
refinance. If your closing costs are $2,500 and you'll be enjoying monthly
payments that are $100 lower, then it will take you 25 months to break even so
that the refinancing was worth it.
If you won't be able to reduce your loan's
interest rate by about 1 percentage point, a general rule of thumb suggests
that going through the trouble of refinancing may not be worth it.
If you're refinancing in order to take out some
of your home equity, think twice. You'll often end up with a bigger loan
balance than you had before refinancing, and less equity in your home, too. In
exchange for that, you did receive a chunk of change, but if you used it to
remodel a kitchen or buy a new car, you probably won't come out ahead,
financially. The car will start depreciating immediately, and most remodeling
costs more than any increase in value when you sell the home. Only cash out if
you really need the money. Every dollar you borrow with your mortgage will
likely take a long time to get paid off, costing a lot in interest.
If you're refinancing in order to consolidate
debt, perhaps because you'd like to pay off high-interest rate credit card debt
with low-interest mortgage debt, think twice. It can be an effective strategy, but if you're
saddled with credit card debt because you tend to spend beyond your means, then
you're not likely to suddenly change your ways. You'll instead be taking on
more long-term debt, while feeling unburdened by credit card debt and perhaps
feeling freer to spend beyond your means again.
Think your situation
through to see if refinancing is a smart move for you. It is for many people,
potentially saving them tens of thousands of dollars.
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