Refinancing your home is a big decision with a lot of moving parts. There are a lot of things to consider, including current interest rates, how long you plan to live there, and how long it will take to recover your closing costs. Some of these factors are more important than others, so it’s completely understandable if you’re sitting on the fence.
Depending on your situation, refinancing your home could be either an expert financial decision or a worrisome financial misstep. That can be a lot of pressure, but we’d be happy to help you out! To get you started, we’ve put together some refinancing advice for you to consider.
Know how long you are planning to live in your home.
Making a decision about how long you plan to live in your current home is one of the first things you want to do before refinancing. In fact, this decision should probably be the cornerstone of all your refinancing research, and honestly it’s equally if not more important than this week’s loan rates.
There are some pretty obvious reasons why your expected length of residency is important to know. If you know you’re going to move next year, for example, then you probably shouldn’t worry about refinancing. If you plan to stay in your home at least a few more years, then you probably should look into it. But this knowledge is also crucial for calculating your payments and your monthly and yearly savings once the refinance is complete.
Consider your closing costs
Whatever your reason for refinancing, you’re going to have to pay closing costs, which will affect how much you might save. Closing costs are usually between 3% and 6% of the total loan amount.
There are a few ways to lower the costs, including building them into the new loan. With enough equity, you might be able to do just that, but be aware that this will increase your principle. Some lenders offer “no cost” options with higher interest rates. Be sure to shop around and see what different lenders are offering, and make sure it works out best for you.
Once you know your expected closing costs, you can compare them with your new savings. If you’re saving $125 per month (or $1,500 per year) but your closing costs were $6,000, it would take four years to break even.
There are good (and bad) reasons to refinance
A lot of people get excited about refinancing when they see a new, low rate. And they’re right! Kind of. Low rates are great, but there are also other things you should think about before signing on the dotted line.
Just because a rate is lower doesn’t mean it’s automatically a good idea to refinance. If you can find a rate that’s 1% lower than your current rate, or even more, then you’re likely making a wise decision. If the rate is not at least 1% lower, however, you should double check to make sure it’s actually going to save you money.
Alongside a lower rate, it’s a good idea to refinance if you can change the term of your home loan, and, as a result, pay significantly less in interest over that term. If interest rates fall, you might have the opportunity to shorten your loan term. You might be paying the same amount each month, or even a little more, but a shorter mortgage term could mean bigger savings.
A third reason to refinance is to change the type of loan. Some people refinance their home loans so that they can switch from a fixed rate mortgage to an adjustable rate mortgage (ARM), or vice-versa. If rates are falling, it can be a good idea to switch over to an ARM to take advantage of lower rates, especially if you’re planning on moving in a few years. On the other hand, you might want to lock in a lower fixed rate, instead.
Remember your individual finances are what’s most important
People do refinance their home loans for other reasons, such as tapping into their equity or consolidating debt. However, these reasons aren’t as financially sound as the others we’ve mentioned above. Homeowners should be careful when making the decision to refinance, to avoid a cycle of never-ending debt.
One last thing: Before you start talking to lenders about refinancing, you need to know what you’re bringing to the table. You should know your home’s equity, your credit score, how much you owe, and how much income you make. All of these are factors that will be used by the lender to determine whether you qualify.
Refinancing can be an excellent financial decision if you end up with a lower monthly payment, a shorter loan term, or if it helps you build equity. Before you decide to refinance your home loan, take a careful, honest look at your finances and how much you’re going to save.