While it may seem complicated, the decision to refinance or not is usually based on a simple cost vs. benefit analysis. In fact, homeowners are often unaware of the opportunities available that may lead them to consider refinancing. Here are a few questions beyond simply comparing your current rate and payment to the potential new rate and payment.
How long do you plan to live in your home?
There are two reasons why this question is relevant. First, this question may begin the process of considering a refinance. Most people enjoy the long-term stability of a fixed-rate mortgage, but if you know you will be moving at some point in the future it may make a lot of sense to refinance into an adjustable rate mortgage with an initial fixed period. For example, if you know you will be moving in two years, an adjustable rate mortgage with a rate that is fixed for the first three years could save you the money you are paying for the unnecessary security of a fixed-rate mortgage.
The second reason this question matters is because you may have to pay some closing costs, either out of pocket or in the loan amount, to complete the refinance. It is a good idea to compare the monthly savings versus the costs to determine how many months it will take for the savings to exceed the costs. There is no right answer as to how long that should be as it depends on your expectations. Technically, if you are certain you will be in the home long enough to realize a savings, the refinance is a benefit.
Who is paying the closing costs?
In some circumstances, we, the lender, may be able to pay the closing costs of your refinance. This is not the same as “rolling them into the loan.” While that is often a possibility as well, you are still paying the costs, you are just doing so over the life of the loan. In some circumstances, we can credit you the money necessary to pay the closing costs on your behalf in return for a slightly higher interest rate. While the higher rate may mean a few dollars more per month in your new monthly payment, this can reduce the amount of money you need to put forward right now; perhaps all the way down to $0.
What type of loan do you currently have and what is available?
In addition to the “how long” situation discussed above, there are other potential scenarios where the loan type can influence the decision to refinance. For example, if there is a significant difference between your current rate and the available rate and you have had your loan for a few years, the payment on a 15-year fixed rate may not be that much higher than your current payment. This may not be a benefit if your goal is to significantly reduce your monthly payment, but if you are fine with the current payment, reducing the term of the loan could mean thousands of dollars in savings over the life of the loan and the chance to own your home free-and-clear much sooner.
Another instance where the loan program might influence a decision to refinance is if you have an Adjustable Rate Mortgage (ARM) and it looks as though interest rates will be increasing in the future. That might be a good time to refinance into a fixed rate.
Are you paying mortgage insurance?
The rule of thumb for conventional (non-government insured) loans is that mortgage insurance will drop off when the amount you owe is less than 80 percent of the value of your home. Here’s the catch: it does not automatically drop off until the loan amount drops below what the value was when your current loan was originated. Any appreciation in the value of your home will not be considered. If you are sure the value has increased enough, a refinance could allow you to get rid of the mortgage insurance payment far sooner than it will take you to pay the loan down to 80% of the original value.
The best thing to do if you are considering refinancing is to contact me. I can provide information and help you evaluate all your options so you can make the best decision for your financial future.