One of the few silver linings in the COVID-19 pandemic is that interest rates have plunged to all-time lows. If you’ve been wondering when to refinance your mortgage, there might be no better time. Depending on your existing rate, you might be able to save hundreds of dollars per month on your mortgage payment.
The best reason to refinance your mortgage is to reduce the interest rate on your existing mortgage; typically, you should aim to reduce the interest rate by 2% or more. But even a smaller rate drop could end up being a good move, as long as your costs and fees don’t overwhelm the amount of your savings. Here’s a look at the ins-and-outs of mortgage refinancing to help you answer the question, “Should I refinance my house?”
- What Is Refinancing?
- When Should You Refinance Your Mortgage?
- What To Look Out For When Refinancing Your Mortgage
- How Long Does It Take To Refinance a Mortgage?
- When Should I Refinance My Home?
When you refinance a mortgage, you’re essentially taking out a new mortgage to replace your existing one. You’ll need to qualify for the new mortgage the same way as you did when you took out your original mortgage.
The whole point of refinancing is to improve the terms of your existing mortgage. And the stronger you can make your credit profile before you apply, the better. If you can’t qualify for a better mortgage, then there is no point in refinancing.
The purpose of refinancing a mortgage is to save money. Generally, mortgage holders refinance when interest rates have declined. However, the drop should be relatively significant before you take all the steps to refinance. This is because refinancing is a process that involves extra costs, paperwork, time and hassle.
If you can only save $20 per month on your mortgage by refinancing, for example, it’s not worth the effort. If you can save thousands of dollars per month, however, then refinancing is likely a smart move.
Saving money is the usual motivation behind refinancing a mortgage. However, the benefits of refinancing a mortgage can be multifaceted. Here are the four main perks of refinancing a mortgage.
- Leveraging Lower Interest Rates: When mortgage rates go lower, you can save money on your interest payments. Over the life of a 30-year mortgage, refinancing a drop of 1% or more, or even 0.5% in some cases, can make a huge financial difference.
- Eliminating Private Mortgage Insurance: If you buy a home with a down payment of less than 20%, private mortgage insurance is usually required. PMI helps protect lenders if borrowers can’t make their payments. If your home equity value has risen above this 20% threshold, you could reap an extra benefit by refinancing. In addition to getting a lower interest rate, you may be able to avoid paying PMI on your new loan.
- Getting a Better Loan Term: Depending on your financial situation, you may want to either extend or shorten your current mortgage loan term. If you’d prefer the flexibility of lower payments, you can refinance into a new, longer-term loan. If you want to pay off your mortgage faster and save in overall interest costs, you can refinance into a shorter term.
- Taking Money Out: With a cash-out refinance, you take on a new loan with a higher balance than what you currently owe on your mortgage. For example, if you owe $300,000 on your current mortgage, you can take out a new loan for $320,000 and use the extra $20,000 for any purpose you like, such as paying down high-interest credit card debt.
In some cases, the cons of refinancing your mortgage can outweigh the benefits. Here are some notable drawbacks of mortgage refinance.
- High Closing Costs: Although fees can vary based on your loan, local taxes and other fees, you can expect closing costs to reach $5,000 or more. If your new loan saves you $100 per month, $5,000 of closing costs will take 50 months just for you to break even. If you end up selling your home in four years, you may have been better off not even refinancing in the first place.
- Burdensome Paperwork: Refinancing your mortgage isn’t like buying a bond, where you can move your money instantly to an instrument with a better rate. To refinance your house, you’ll need to apply for a brand-new mortgage, with all of the required documentation. You should expect to provide everything from appraisals and proof of income to insurance verification.
- Delayed Mortgage Payoff: If you refinance your mortgage into a new 30-year loan, you’ll no doubt be adding additional years on to your mortgage. Although your monthly payment might become more affordable, you’ll be paying for a longer period of time.
- Damaged Credit Score: Applying for a mortgage refinance will result in a hard pull on your credit report. Although the damage might be significant, you can expect your credit score to dip, whether or not you are ultimately approved for your loan.
Just because your interest rate drops by a fraction of a percentage point doesn’t mean you should rush out and refinance your mortgage. One of the most important calculations you can make is what your break-even point will be for closing costs.
Take the example of a mortgage interest rate dropping by 0.5%. Is it worth it to refinance in that case? Like so many financial decisions in life, it depends. If you have a $400,000 mortgage, for example, and your rate drops from 3.75% to 3.25%, you can save roughly $100 per month — or $6,000 over five years. While that might sound like a good deal, your closing costs could easily equal or exceed $6,000. This is by no means a no-brainer — unless you are 100% sure you will keep your mortgage for at least five years.
If you intend to take cash out of your mortgage and use it to pay off some high-interest credit card debt, that might be a smart move. However, you’ll have to be sure that you can manage your debt responsibly. If you pay off your debt and just run it back up again, you’ll be left with a longer-term mortgage and the same high-interest credit card debt, trapping yourself in a debt spiral.
The bottom line is that you can’t just decide to refinance your mortgage when rates move slightly lower. Incorporate your entire financial picture into the equation before you take such a major step.
Generally, you can expect the mortgage refinance process to last between 30 and 45 days. However, this estimate can vary widely based on a number of factors. When you refinance, you’re essentially applying for a brand-new home loan.
In addition to the inspections and appraisals that are involved, underwriters will have to evaluate your credit and finances. If paperwork is not completed properly or if there are delays in documents flowing back and forth between borrowers and lenders, the process can take longer. The more prepared you are before you begin your application, the more likely the refinance can run smoothly and according to schedule.
Taking a major financial step like refinancing your home is a decision best made with your financial or tax advisors. However, the bottom line is that you should refinance your home when you feel rates have dropped significantly enough for you to be in a better overall financial position. Otherwise, it’s likely not worth it.
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