Is it a Good Idea to Refinance Your Mortgage?

Deciding whether or not refinancing your mortgage is a good idea is a completely personal choice. Understanding your financial goals and needs will go a long way in helping you answer this question. However, there are a number of advantages and possible disadvantages to consider.

In this article, we will review when refinancing is generally beneficial versus the possible risks you need to be aware of before jumping into the process.

When is it worth it to refinance?

Refinancing can be a powerful tool for homeowners looking to make a smart financial move. Not only can it save you money on interest or your monthly mortgage payments, but a home loan refinance can also offer a strategy for tapping into your home’s equity. However, the most important question you can ask yourself before refinancing is, “Will this make sense and benefit me financially?”

On top of identifying your personal goals, it is important to research current market interest rates and review your current financial situation.

Will you benefit from refinancing your mortgage?

It is common for mortgage refinances to become more popular when interest rates start to drop, but there are a few other factors to consider. Most experts agree that refinancing makes the most sense in instances where you can obtain a rate that is 1% less than your current mortgage. While overall market trends do play a significant role in determining the lowest rate possible, your finances also have a big impact.

Here are a few signs that may indicate refinancing your home loan will be beneficial:

1. You have maintained good credit, or it has improved recently.

Similar to the homebuying process, your credit score continues to have a significant impact on your mortgage rate when you refinance. A higher score can help you obtain a lower interest rate and ultimately save you more money in the long run.

Most lenders will require a credit score minimum of 620 to qualify for a refinance. However, if you are able to take the time to improve your score even more, you may be approved for a lower rate that will save you thousands.

2. You can change from an adjustable-rate to a fixed-rate mortgage.

In many instances, borrowers who opted for an ARM loan initially will choose to refinance as a way of avoiding possible increases in their rate. Refinancing to a fixed-rate mortgage can offer you peace of mind that your monthly payments will be consistent.

3. Your home’s value has increased, or you have built at least 20% equity.

Another benefit of refinancing can be the ability to tap into your home’s equity with a cash-out refinance. You can use the money to consolidate high-interest debts, pay for education expenses, or invest in home improvement projects. However, it is important that you have enough equity built up (typically 20% or more). It is important to note that a cash-out refinance will replace your current mortgage with a larger loan in order to provide you with the cash surplus.

When it comes to experiencing the benefits of refinancing, timing can be key. If your finances are not in order, or interest rates are increasing, it may be better to hold off on a mortgage refinance rather than risk succumbing to any refinance pitfalls.

What are potential risks of refinancing?

As many reasons as there are to consider a refinance, there are a few risks that you need to be aware of as well, including:

1. It takes time to break even.

Refinancing can be a great strategy for saving more money in the long run. It can even reduce your monthly mortgage payments immediately. However, you must take the closing costs and fees into account when weighing the risks and benefits. Though you will not be required to provide another down payment, the cost to refinance will include closing costs and lender fees that you will be responsible for covering.

You can expect these fees to total between 2% to 5% of your new loan’s balance. Not only will you need to take the time to save for these costs, but it will then take time to recoup those funds and break even on your refinance.

2. It will affect your credit score.

Refinancing does have an effect on your credit score, as lenders will need to perform a hard inquiry to assess it. You can expect a temporary drop in your score, but it should recover within a few months as long as you maintain good habits and timely payments.

3. It may increase your monthly payments or interest.

If you decide you want a cash-out refinance, it is important to be prepared for an increase in your monthly mortgage payments as the new loan will be larger than your first. This can also be the case if your goal is to switch to a 15-year mortgage in order to pay it off faster. (Another important thing to note is that a cash-out refinance will also reduce the equity in your home.)

Remember, your situation is unique and just because refinancing is right for someone else, that does not mean it will be the right strategy for everyone.

What is the 80/20 rule?

If you are interested in a conventional refinance or cash-out refinance, you may hear references to the 80/20 rule. This rule simply refers to the amount of equity you typically need in your home in order to refinance. You normally need at least 20% equity (or your LTV ratio is not higher than 80%) to conduct a cash-out refinance or avoid paying for private mortgage insurance on the new home loan.

Mortgage refinance options

Understanding the different types of refinance options available will also help you determine if refinancing is the right path for you. Here are the most common types of refinancing you will have to choose from:

• Rate-and-term refinance

• Cash-out refinance

• Streamline refinance

• VA loan refinance

Regardless of whether or not you already have a refinance type in mind, it is best to compare lenders and reach out to discuss all of the refinancing strategies that will work best for your needs.

Is refinancing a good idea?

At the end of the day, the only one who can best determine if refinancing is a good idea is you. The refinance strategy that works for someone else may not be the best option for your financial goals. However, taking the time to research your options will give you the confidence to determine if the time is right.

Be sure to keep an eye on current interest rates and take steps to improve your finances in the meantime. As always, we highly recommend reaching out to a trusted lender who can walk you through the process.