November 23, 2020
As you can likely guess, there is no best time to refinance that works for everyone. You should consider multiple factors when you think about refinancing and of course, everyone’s financial situation and needs are unique.
There are a number of different situations that might trigger you to consider refinancing. For one, if home loan interest rates decrease, you’ll hear in the news, “Mortgage rates are falling, time to refinance.” While this is a great reason to consider refinancing, there are other reasons why refinancing might be equally compelling for you.
- You can eliminate mortgage insurance. If you placed less than 20% down on your home and don’t have a VA loan, you likely carry some type of mortgage insurance. In general, you can reduce private mortgage insurance (PMI) once the equity in your home exceeds 20%. However, mortgage insurance premiums (MIP) may be required for the duration of your loan. If your equity in your home exceeds 20%, you may want to review rates to see if a refinance will allow you to eliminate your mortgage insurance.
- You can pay off your mortgage more quickly. If rates have dropped enough from your current mortgage, or if you have more monthly income, you may be able to consider reducing the overall term (length) of your mortgage. This can save you thousands of dollars in interest over time. Imagine only having to pay your mortgage for 15 years rather than 30.
- You can consolidate debt or get cash. If you have credit cards with high interest rates, student loans, or need cash, you may be able to tap into the equity of your home with a refinance.
- You want to change your loan type. It might make sense to refinance to change the type of loan you have. A good example would be to change from an adjustable rate mortgage (ARM) to a lower fixed rate mortgage that stays constant over the life of the loan. This can give you a sense of security because you’ll know what your long-term housing expenses will be and won’t have to worry about changing interest rates.
What are the costs of refinancing?
You’ll need to factor the refinancing process and its costs into your equation to determine if refinancing is right for you. For example, some people are simply looking to save money over the life of the loan by refinancing to a lower rate. Depending on the rate difference between your current and new loan, and the cost to refinance, it may take several months to break even. You also need to consider how much longer you intend to be in your home. If you’re planning on moving in a year or two, a refinance now might not make financial sense.
Here are some of the costs you may incur during a refinance:
- Appraisal fees
- Title fees — you’ll need to document the title of the property
- Attorney fees
- Recording fees
- Points — you can pay points just like during a purchase, where one point represents 1% of the loan amount
Is it worth refinancing for .5% rate reduction?
Traditional advice used to be a minimum of 1% difference in rates would make it worth your while to refinance. That may not always be the best advice. The best way to determine if the rate reduction is worth a refinance is to use a mortgage calculator to determine the difference in your monthly payment. Let’s look at a simple example of a $350,000 home and compare the difference between a 5.5% interest rate (assume $0 money down payment in this example), and a 5.0% interest rate (a .5% reduction):
$350,000 home 30-year fixed mortgage:
- 5.5% interest rate = $1,987.26 principle and interest monthly charge
- 5.0% interest rate = $1,878.88 principle and interest monthly charge
In the example above, your monthly savings between 5.5% and 5.0% with a 30-year mortgage is $108.38 per month. Over the life of the loan (30 years) that is a significant savings.
However, if you estimate an approximate $3,000 in closing costs (sometimes they can roll those into your new loan) it would take you more than 26 months to break even. If you plan on being in the home for several more years, or if you are looking to refinance for additional reasons like we outlined above, refinancing can make perfect sense with a .5% reduction in rates.
What will refinancing do for my credit score?
When you look to refinance your mortgage, there is a “hard inquiry” on your credit. That means your credit score is briefly affected while you are looking at obtaining a new loan. If you review your options with several lenders over a short period of time (typically under 30 days), credit rating agencies may perceive it as only one inquiry to your credit and not multiple hits. Therefore, its best to keep your search to a 30-day period if you’re going to shop around between different lenders.
Once you obtain a new mortgage, you’ll pay off your existing mortgage with the refinance. However, you still need to build a history of payments with the new lender or new loan. As you continue to make all of your payments on time, your credit score will once again improve.