How to Decide When to Refinance a Mortgage
Owning a home is many people's dream, one that many, many people are currently living. Frequently though, home buyers don't know enough about what they are doing when they take out a mortgage and end up with a loan that really isn't the best for them. Many times buyers don't have the greatest credit which will definitely affect what kind of rate you receive and could affect other aspects of the mortgage as well. Refinancing a mortgage can fix some of the problems with an original mortgage. How do you know when it is a good time to refinance your mortgage?
The first thing to look at is your interest rate versus the current interest rates available right now. If your interest rate is higher than the current rate, chances are good that a refinance would be a good idea. If your credit has improved since you first took out your mortgage the chances of lowering your interest rate are better. If you can get a full percentage point or more lower on a refinance then it could be a good financial move to make.
If you don't already have a fixed rate mortgage, then I would highly recommend that you refinance as quickly as possible. ARM loans go up in interest each year. Supposedly they are adjustable rate mortgages, but I have never seen an ARM loan go down. If you have an interest only loan at the moment, please consider refinancing. Paying interest only does not save you money in the long run and it doesn't save you very much at all in the short term. It might reduce your monthly payment by $100-200 for a short time, but the payments will go up. Refinancing to a fixed rate mortgage is your best bet if you have an ARM or interest only loan.
Another thing to consider is how long you plan on being in your home. If you get transferred every couple of years with your job, refinancing might not be a good move. If you are thinking about moving up in home in a few years, you need to think very hard before deciding to refinance. Refinancing does typically save you money each month but it is a fairly expensive process to go through.
Refinancing typically comes with lots of closing costs - around $3,000. You want to make sure that your costs will be paid back to you within a couple of years. So if you can save $100 a month by refinancing and the closing costs are $3,000 it will take you 30 months to make your money back and really start saving money. Many mortgage companies will let you roll your closing costs into the loan; however that just adds more money to your mortgage which isn't always a good idea. If you can pay the closing costs out of pocket that would be best.
Something else to consider is PMI - principal mortgage insurance. Typically if you do not have 20% or more in equity in the home the mortgage companies will require that you have PMI. This doesn't have to mean that you paid off that 20% however. When we lived in our first house, it appreciated so much in just a few years that we were able to refinance based on a new appraisal amount and drop our PMI. We lowered our interest rate slightly, but the big savings came in no longer having to pay this insurance. We saved $250 a month by doing this.
There are other things to consider when thinking about a refinance though. How long have you been paying on your mortgage? If you had a 30 year loan to start with and now only have 20 years left, how would it feel psychologically to start over with a 30 year loan? Even if it did lower your rate a good bit, starting over will cost you a lot of money in interest. You pay the most interest at the beginning of a loan. Gradually you will work your way to paying more principal, but it takes years and years to really make a dent in it.
Many people will choose to refinance to a 15 or 20 year mortgage. This way the term of the loan is shorter and the interest rate is usually lower. The problem most people have is that it increases the overall payment a good bit - because so much more money needs to go to principal to pay off the loan in the shorter amount of time. You can save hundreds of thousands of dollars in interest though, by taking out a 15 year loan rather than a 30 year loan, so it is something to consider. If you are refinancing lowering the term amount will save you a lot of money in the long run - even if your payments are the same or more each month.
Actually right now is a good time to refinance an existing mortgage loan. The housing market might not be great, but staying where you are and getting better terms on the mortgage on your home could be a great move to make financially. Don't forget to shop around though. Many times the company that you have your existing mortgage with will waive some minor fees when it comes to refinancing but you might still find a better deal elsewhere. Consider all the aspects of refinancing that I mentioned here to help you make a good decision for your situation.
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