Contrary to what some may think, signing your
mortgage loan documents does not mean you must stick with that deal forever. If
rates change or events arise which prevent you from paying as you had planned,
refinancing might be an effective way to adjust your monthly mortgage payment.
Refinancing means paying off your existing
mortgage with a new one, potentially with a lower rate and payment. Refinancing
typically involves some costs such as appraisal and loan origination fees,
which can add up to as much as 3% to 6% of the amount you are refinancing. The
following scenarios are ones in which refinancing could be worth considering.
Your
credit has improved
If you received your mortgage at a time when
you had average credit or a short credit history and your score has since improved, you may now qualify for a
lower rate. If so, you may be able to pay off the principal faster and build
equity.
Interest
rates drop
The market may have changed since you obtained
your mortgage. Many experts recommend refinancing if you find a rate at least
one percentage point lower than your current rate. This can save you tens of
thousands of dollars in interest costs over the span of your loan.
You
want to consolidate other loans
With cash-out mortgage refinancing, you take
out a loan for more than what you owe on the home. For example, say your home
is worth $400,000 and you still owe $150,000. You could take out a new mortgage
for $200,000, with $50,000 coming to you in cash. This can be handy if you would
like to consolidate any high-interest debts such as student loans, credit card
balances or auto loans. When you take cash out this way, though, you reduce
your home equity.
You
want to switch from an adjustable to a fixed-rate loan
If you have an adjustable-rate mortgage, or
ARM, you run the risk of higher payments, which can be hard to handle long-term
if you have a level income. Refinancing may enable you to switch to a
fixed-rate loan and take the uncertainty out of your mortgage payment plan,
which is especially beneficial if you think rates will increase over time.
You
want to change your monthly payment
You may be able to extend your mortgage term
to reduce your monthly payment if your current one is not affordable anymore.
On the flipside, you may also slide the term, possibly with a 15-year loan to
replace your 30-year term. This would raise your payments, but you pay off the
debt more quickly.
When
not to refinance
Although refinancing has its advantages, it is
not for everyone. Bear in mind that if any of the following apply, it may not
be a good idea.
·
You
have had your mortgage a long time. For most 30-year mortgages, you pay most of the interest in the
first two decades of the loan. After that, more of your payments go to reducing
the principal balance than paying interest, so refinancing would probably mean
spending much more on interest than you would if you keep your current loan,
even if the rate is high.
·
Your
mortgage has a prepayment penalty. Your lender may charge you for paying off the loan too early. A
penalty fee can range from one to six months’ worth of interest payments, in
addition to the other costs of refinancing.
·
You
plan to move soon. Refinancing can help
save you money in the long term. If you plan to leave your home in the next few
years, you might not reach the break-even point when the monthly savings on payments surpass the upfront
refinancing costs.
In certain situations, refinancing is a
productive strategy. If it is early in your mortgage, you need to pay off other
high-interest debt or you can improve upon the terms of your current loan,
refinancing could be a money-saving move.
Spencer Tierney is a staff writer at
NerdWallet, a personal finance website. Email: spencer@nerdwallet.com. Twitter: @SpencerNerd.
