It’s a question homeowners ask when interest rates tumble: Should I refinance my home mortgage or stick with the loan I have?
While a home refinance may ultimately be a smart financial move, a number of questions must be considered first that will help evaluate your specific situation.
Here are some of the top questions to keep in mind:
Can I lock in a fixed interest rate or lower my interest rate?
Locking in a fixed or lower interest rate or lower payment are good reasons to refinance.
Homeowners with a variable rate mortgage, for example, might want to refinance to a fixed rate loan to avoid higher payments if rates rise. With fixed rate loans, the monthly payment stays the same for the life of the mortgage. Snagging a lower interest rate that results in savings on your monthly mortgage cost might also make refinancing a good option.
“Typically, lenders will offer a selection of refinance loan types and can lock in a rate once the borrower is ready to apply,” said John Cabell, director of wealth and lending intelligence for J.D. Power. “The exact monthly payment may be hard to pin down until all transaction fees are finalized, and sometimes those details are not finalized until closing.”
Can I lower my total interest expense?
Paying less total interest over the term of a new loan compared with the remaining term on an existing loan can be another good reason to refinance. However, in some cases switching to a mortgage with a lower rate but a longer term could result in you paying more interest over the life of the loan despite having a smaller monthly payment.
Bankrate’s refinance calculator can help you do the math.
Do I have enough equity?
If your home is worth more than you owe on your existing mortgage, you’re in a much better position to refinance than if you have no equity.
A home with a lot of equity built up will have a lower loan-to-value ratio (LTV), which banks prefer as it makes the loan less risky. An LTV of 80 percent or less also eliminates the need for private mortgage insurance. It also makes it easier to refinance for a larger amount than your existing mortgage, known as a cash-out refinance. Funds raised in a cash-out can be used to pay down debt, fund home improvements or help with college costs.
“By studying nearby home sales and speaking with a local realtor, you may be able to get a general idea on the value of the home,” said Sherry Graziano, senior vice president and mortgage transformation officer at SunTrust. “You can then compare that to what you still owe on your mortgage to see what equity you have built. If it’s too little, it may not be worth refinancing and may not meet the lender requirements.”
Is my credit score high enough?
If you have a good history of making your mortgage payments and paying your other bills on time, you’re in a much better position to refinance than if you’ve made some late payments or missed any payments that hurt your credit rating.
“Your credit score will affect your eligibility for loans and low interest rates,” said Cabell. “Knowing your score before applying for a refinance and building a good score over time are important for ensuring you have the most financial flexibility.”
Lenders should be able to tell you up front whether you’re qualified for specific refinance offers based on your credit score.
How much will I pay in closing costs?
It may not make sense to pay points and closing costs to refinance even if you could lower your interest rate, payment or total interest expense.
“Generally, the amount of closing costs you’re willing to pay should not exceed the financial benefits of the lower refinance interest rate,” said Cabell. “That fact requires validating before you commit to the transaction, though, so consumers should make sure the lender provides assurance in writing.”
A rule of thumb is to calculate how many months it will take to recoup your closing costs. Let’s say your closing costs are $3,000 and your monthly savings are $125 after the refinance. It would take you 24 months to breakeven and start enjoying the cost savings of the lower interest rate on the new mortgage.
It’s also worth noting that some lenders offer a no-cost option that lets you get the benefits of refinancing at a higher interest rate without paying any costs. This typically comes with a higher interest rate, however.
How long do I plan to own my home?
Yet another factor to consider before embarking on a home refinance is how long you expect to own the property. If you’re planning to move within a few years, refinancing may not make sense, even if you could get a lower interest rate.
The reason? There might not be enough time to offset your closing costs, despite a lower monthly payment.
“If the borrower is considering selling the property within the next few months or couple of years, it may not be advisable to refinance since the borrower may not recoup the upfront fees and interest over such a short timeframe,” said Cabell.
On the other hand, you may be able to lower the upfront costs if you’re willing to accept a slightly higher interest rate. But that could mean that it wouldn’t make sense for you to refinance.
What costs are involved in a refinance?
Refinancing can cost hundreds or thousands of dollars, depending on the loan amount, the type of loan, the region of the country where the property is located and other factors.
Typical costs include an appraisal fee, credit report, title insurance and closing or attorney’s fees.
“The cost to refinance will depend on the lender and associated third parties, so it pays to understand those cost obligations before committing,” said Cabell.
Reasons to refinance a home loan
Just because rates are at historical lows, doesn’t mean refinancing is the right decision for everyone.
“Homeowners should have a clear financial objective and see refinancing as one of a multitude of options to achieve that objective,” said Graziano, who outlined the following key reasons one might want to refinance.
- To alter the terms of the loan by shortening or lengthening the life of the loan
- To take advantage of a lower interest rate, resulting in lower monthly payments and paying less total interest over the term of a new loan.
- To replace an adjustable-rate mortgage with a fixed-rate mortgage
- To consolidate debt or to finance educational expenses or home improvement projects