With interest rates near record lows so long that rising rates seem imminent, it’s smart to at least consider refinancing your home mortgage.
A lower interest rate could give you plenty of advantages, after all. While loan outcomes vary, lower interest rates can easily lead to lower monthly mortgage payments and interest savings. Under the right circumstances, you could even shorten the repayment timeline for your loan and pay off your home faster.
But, should you refinance your mortgage? That’s a question only you can answer, but only after weighing the pros and cons and running the numbers for your unique situation. With that being said, there are some situations where it almost always pays off to refinance – and other situations where it rarely makes sense.
5 Signs Now Might Be the Perfect Time to Refinance
If you’re on the fence about taking the steps to refinance your home, it’s crucial to figure out how and why a refinance could leave you better off. Here are five signs you should definitely consider refinancing your mortgage before rates surge:
Your interest rate isn’t competitive…
If you purchased your home five or ten years ago, chances are good your interest rate is higher than what is offered today. In that case, considerable savings could be yours if you go through the trouble to refinance. If you could save even one percentage point, that hassle and stress could be well worth it.
Let’s say you purchased your property in 2010 when the average APR for a thirty-year fixed rate loan was around 5.5 percent. The principal and interest on your $250,000 loan has been $1,419 per month all this time. Seven years later, you owe around $220,000 on your home.
Since you can currently get a twenty-year fixed rate mortgage at around 4 percent APR with great credit, you could potentially refinance to save money and pay off your home faster. With a new twenty-year fixed-rate loan at 4 percent, principal and interest would be just $1,333 per month.
You want to pay off your house faster…
If your goal is paying off your home faster, there’s more than one way to get there. You can either a) pay extra toward the principal of the loan you have, or b) refinance into a new loan with a shorter repayment timeline.
If you can lock in a lower interest rate, your new payment on a fifteen or twenty-year mortgage may not be much more than a thirty-year loan. Using the example above, P&I on a thirty-year loan is $1,419 per month at 5.5 percent APR. If you chose a 15-year mortgage and qualified for 3.5 percent APR, your P&I payment would only inch up to $1,787 per month.
You have 20 percent equity, but you’re still paying PMI…
If you purchased a home with less than a 20 percent down payment, chances are good you’re paying PMI, or private mortgage insurance. This added cost will set you back around 1 percent of your home’s purchase price every year, yet offers no value for you, the consumer.
If your home has increased in value or you have paid down enough of your mortgage that you now own 20 percent equity, refinancing your home could help you ditch PMI altogether. Once you stop paying PMI, you could throw those extra dollars toward your mortgage to pay it down faster or pocket the difference.
You have an adjustable rate mortgage and want to lock in a fixed rate…
An adjustable rate mortgage can help you save money on interest while rates are low. Unfortunately, adjustable rates don’t stay low forever, and if you don’t lock in a new rate, you could get “stuck” paying more interest than you want.
By refinancing your adjustable rate mortgage into a new fixed-rate loan, you may be able to lock in a lower rate and save money in the process.
Your credit score has improved dramatically since you purchased your home…
If your credit was less than stellar when you purchased your home, you’re probably paying more interest than you should. Like it or not, lenders boost rates for borrowers who have shaky credit to make up for their increased exposure to risk.
If you’ve worked hard on your credit score since you bought your home and think you could qualify for a lower rate and better terms, there’s only one way to find out. By shopping for a new loan and applying for a mortgage refinance, you can run the numbers and decide.
Three Reasons You Shouldn’t Refinance Your Mortgage
While the idea of refinancing your loan might sound appealing, there are plenty of circumstances where it doesn’t make sense – even if you can get a lower rate. Don’t apply for a new home loan without thinking through these important reasons to skip a refinance altogether:
You plan to move in the next few years…
While refinancing your mortgage into a new loan with better terms can pay off over the long haul, it’s important to consider the upfront fees you’ll pay. Just like any other loan, you’ll have to pay an origination fee and other closing costs to get your new loan started. While a lower interest rate can lead to savings that make these added costs worth it, your timeline to break even may be longer than you think.
The bottom line: If you plan to sell your home and move within five years, refinancing your home – even at a lower interest rate – may not be a smart financial move. To find out, you need to compare the total costs of a potential new loan to the loan you have. Run the numbers, then decide if it makes sense.
You recently switched jobs or became self-employed…
If your work situation has changed since you purchased your home, refinancing may be a bad idea. Let’s imagine for a moment you switched industries with a three-month gap in employment. While some lenders may not give this much thought, others might deny you outright unless you meet their criteria for continuous employment – which could require up to 24 months of continuous work.
If you’ve become self-employed since you purchased your home, this could be another mark against you. Most lenders want at least 24 months of reported self-employment income before they’ll even consider you for a mortgage. Without the tax information and history to back up your income, you could be out of luck.
Your credit is worse than it was when you purchased your home…
While better credit is a smart reason to consider a refinance, a declining credit score is a good reason not to refinance. Without good or excellent credit, you may not qualify for a home loan with the best terms and interest rate. If that’s the case, your new home loan could actually leave you worse off.
Suffering from bad credit? Instead of refinancing, look for ways to boost your credit score over the long run. That could mean applying for a new credit card to add some much-needed depth to your credit history, making sure to pay all your bills on time, paying down debt, or all of those things.
A home refinance can be a smart move, but that doesn’t mean it’s worth it for everyone. Before you go through the trouble of applying for a new mortgage, look closely at your situation and your loan. Ask yourself how much you could save with a refinance and if the savings would be worth the hassle and stress.
If you find the pros of refinancing outweigh the cons, go for it.
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