Should I Refinance My Mortgage?
When you secure a residential mortgage to purchase a home, the loan term is typically for 15 or 30 years. Although the duration of your home loan might be for 30 years, that doesn’t mean that you will necessarily have your loan for that long. If interest rates drop or your home’s value goes up, it can make sense to refinance your mortgage, replacing your old loan with a new one.
Refinancing can help you save money and provide other benefits, but it’s not always the right option. Learn more about what a refinance is, how you can refinance, and when it makes sense to do so.
What Is Refinancing?
When you refinance a loan, you take out a new loan and use the principal from it to pay off an existing loan. If you refinance a mortgage, you take out a new mortgage to replace your current home loan. Usually, there is something about the new loan that makes it better for you than your existing mortgage. The interest rate might be lower, for example, or the new loan might allow you to use your home’s equity. Refinancing can sometimes reduce your monthly payment, making your mortgage more affordable.
The process of refinancing is very similar to the process of getting your first mortgage. You can shop around for the best interest rate and terms. You will also want to compare offers to your current mortgage. During the process, a lender will check your credit score and verify your income to ensure that you can afford the new loan. Your income and credit will also influence the rate you can secure and the amount you can refinance.
Types of Refinancing
Several types of mortgage refinancing are available. The type of loan you choose depends in large part on your overall goals for refinancing. Your options include:
- Rate-and-term refinance: If you select a rate-and-term refinance, either the interest rate or term of your mortgage changes. In some cases, both can change. You might decide to refinance a 30-year mortgage with a 5.5% interest rate to a 15-year mortgage with a 3.87% rate, for example. You can also refinance to change the type of interest you’re paying. For example, if you have a mortgage with an adjustable interest rate, you can refinance to a loan with a fixed rate.
- Cash-out refinance: A cash-out refinance lets you tap into some of the equity built up in your home, converting it to cash. For example, if you purchased your home five years ago for $250,000 and it has since increased in value to $300,000, a cash-out refinance lets you access some or all of the additional $50,000 in equity, (up to a maximum loan-to-value of 80%.) The trade-off is that the amount of your loan will increase when you apply for a cash-out refinance. With a cash-out refinance, you might also change the length of the mortgage, the type of interest, or the amount of interest.
- Lower your mortgage refinance: If you feel the balance on your home loan is too high, and you’d like to reduce it, you can choose this type of refinancing. While a cash-out refinance lets you walk away with money in your pocket in exchange for a larger mortgage, bringing money to closing allows you to shrink the principal balance or pay closing costs out of pocket. You may also get a lower interest rate or a shorter or longer mortgage term.
When Should I Refinance?
Refinancing your mortgage can make sense in many circumstances, but it’s not always the right move. One thing to consider when asking yourself if you should refinance your home is the total cost of the new loan compared to the amount you’ll save. In some cases, the cost of refinancing is much more than your savings, meaning the refinanced loan ends up costing you money. Your plans for the future can also affect whether or not refinancing is the right option for you. Here are a few cases when refinancing can or should be an option:
Reason #1 – Interest Rates Have Dropped
One popular reason to refinance a mortgage is to take advantage of lower interest rates. The interest rates offered on mortgages vary based on market conditions and your credit score. In some years, rates have been considerably higher than in other years. For example, the average interest rate in 2007 was 6.34%. In 2017, the average interest rate was 3.99%. If you took out a mortgage in 2007, refinancing in 2017 could have helped you save money on interest, resulting in a lower monthly payment.
The effect of an interest rate drop is proportional to the size of your loan. In other words, there will be a notable reduction in the payments for a larger mortgage when rates drop slightly, such as 0.5%. If you have a smaller mortgage, such as $100,000, you won’t notice much, if any, monthly savings when rates only dip slightly. If your loan is smaller, you might postpone refinancing until there is a more significant drop in interest rates, such as from 6% to 4%.
Reason #2 – You Have an Adjustable-Rate Mortgage
Adjustable-rate mortgages (ARMs) can be appealing when interest rates are high. Often, the initial rate on an ARM is lower than the rate on a fixed-rate mortgage. FreddieMac publishes average weekly mortgage rates, and ARM rates are usually less than fixed-rates. With an ARM, the rate changes after a set period, such as five or seven years. For example, a 5-1/yr ARM has an initial rate that’s fixed for five years. After the first five years, the rate adjusts annually.
Although an ARM lets you tap into a lower rate initially, there is always the chance that rates will go up in the future, increasing your monthly payment. If you want to avoid climbing interest rates, one option is to refinance your loan, changing to a fixed-rate.
Reason #3 – Your Home’s Value Has Increased
Depending on where you live and how long you have had your mortgage, your home’s value may have increased considerably over the years. If that’s the case, a cash-out refinance can help you tap into the equity of your home. To take advantage of your home’s increased value, you may want to consider a refinanced loan with a principal that is higher than what you currently owe on your mortgage.
For example, five years ago, you purchased a $175,000 house. You put $25,000 down and borrowed $150,000. Over the years, you’ve paid off $25,000, so your principal balance is now $125,000. Meanwhile, your home’s value has gone up to $210,000. As a result, you have $85,000 in equity in your home.
When you refinance your loan, you borrow $150,000, rather than the $125,000 still owed on your mortgage. Some of the principal of your new loan, $125,000, will go towards paying off the old mortgage. The rest will come to you in cash.
Since you are borrowing against your home, it’s essential to use the cash you get from your refinance wisely. Some homeowners re-invest the money in their home, using it to pay for upgrades and renovations. Others use the money to pay down higher-interest or more expensive debts, such as credit card debts. Another thing to consider when refinancing to access your home’s equity is whether you can afford the new monthly payment. Unless interest rates have fallen considerably between the time of your first mortgage and the time of your refinance, your monthly payment will likely go up if you do a cash-out refinance.
An increase in your home’s value can benefit you in other ways, should you decide to refinance. If your initial down payment was less than 20%, you most likely have to pay private mortgage insurance (PMI) on your loan. Depending on the type of loan you have, PMI drops off automatically once your equity reaches 22%. You can also request that your lender remove the PMI once you’ve built up 20% equity. For some loans, such as loans from the Federal Housing Administration (FHA loans), PMI is for the life of the loan. The only way to stop paying it is to refinance your loan to a conventional mortgage.
If the value of your home has gone up considerably over the years, your equity might reach 20% ahead of schedule. In that case, having your home appraised to determine its value and refinancing your mortgage can allow you to eliminate PMI.
Reason #4 – You Want to Add Someone to the Mortgage
Let’s say you bought your home as a single person. Now, a few years later, you’re getting married, and you want to add your spouse to the mortgage. Usually, the most efficient way to add someone to a home loan is to refinance the loan. During the refinancing process, the lender will use both your and your spouse’s information to determine eligibility. If your spouse has excellent credit and a source of income, you might find that you get a better interest rate and can borrow more than you did as a single borrower.
The reverse is also true. If you bought a house with someone and the mortgage is in both of your names, and now one person wants out, you will typically need to refinance to remove that person’s name from the loan and to open up a new loan that’s only in your name.
Reason #5 – You Want to Consolidate Loans
Generally speaking, the interest rates on mortgages are much lower than the rates on other types of debt, such as credit card debt. When you take out a mortgage, your home is the collateral. If you can’t make payments, the lender always has the option of claiming your property. That option isn’t there with credit cards and unsecured debts, so they have higher rates.
If you have a fair amount of high-interest debt and you want to pay it off more quickly, getting a cash-out refinance and using the cash to pay off other debts can be a way to consolidate your loans.
Reason #6 – Your Credit Has Improved
In the years since you got your first mortgage, your credit score has likely improved, especially if you pay your loan on time and never miss a payment. If your credit was only so-so or “good” when you took out your first mortgage, the odds are likely that you didn’t get the best terms and might be paying a relatively high-interest rate. In the intervening years, if your credit score has moved into the “excellent” category, you might be able to save money by refinancing. A better credit score typically qualifies you for a lower interest rate.
Does Refinancing Make Financial Sense?
Another thing to consider when deciding when you should refinance is whether doing so will make financial sense for you. There are fees when you refinance, and in some cases, those fees can be more than what you end up saving. To find out if you’ll save money by refinancing your mortgage, you want to calculate your break-even point, which is the amount of time you’ll need to stay in your home for the savings from your refinance to equal the fees associated with it.
You can calculate your break-even point by dividing the costs of the refinance by your monthly savings. For example, if you reduced your monthly payment by $175 and you paid $5,000 in closing costs when you refinanced, it will take you nearly 29 months to break even:5000/175 = 28.6
If you plan on staying in your home for at least another two and a half years, refinancing can be worth it. If you expect to move before then, you might be better off keeping your current mortgage.
How to Refinance Your Mortgage
Except for house-hunting, the process of refinancing your mortgage has a lot in common with the process of getting a first mortgage. Here’s how to go about refinancing:
- Determine why you’re refinancing:Before you start the process, know why you’re refinancing. Do you need cash to complete a renovation project, or are you hoping to save money by getting a lower interest rate?
- Check your credit:Your credit plays a significant role when it comes to the interest rate you can secure. Before going further, check your credit to make sure it’s good enough to get the best possible interest rates. If your credit isn’t where you want it to be, consider paying off debts and getting any past-due accounts current before moving forward.
- Find a lender:If all seems fine with your credit, the next step is to find a lender. Traditions Mortgage Partners are local, experienced, and ready to help you choose the best option for your situation.
- Lock in your rate:After you’ve spoken with a Traditions Mortgage Partner, work with them to lock in your interest rate so it won’t increase before you close on the loan.
- Gather your documents:Just as you had to submit financial paperwork when you applied for the first loan, you’ll need to submit documentation proving your income, employment status, assets, and other financial details when you refinance. Your lender will let you know the specifics of what you need to provide.
Ready to Refinance? Contact the Mortgage Experts at Traditions Bank Today
If refinancing seems like the right option for you, or if you’re on the fence and would like more information about your options, the team of mortgage experts at Traditions Mortgage is here to help. We are the #1 Home Purchase Lender in York County and can help you choose the type of residential refinance option that will best help you meet your goals. Contact us today for more guidance on whether or not refinancing is right for you and to learn more.