Is It Time to Refinance Your Mortgage
- December 4, 2020
- by Michael
The U.S. Federal Reserve has cut interest rates twice in 2020. These rate cuts have led many people to wonder if it is time to refinance their mortgage. Low interest rates, as well as several other scenarios, might mean that it is a good time to refinance and save money on your mortgage. However, refinancing might not save every homeowner money.
There are three main scenarios in which a homeowner might consider refinancing:
- when interest rates fall
- when their credit score has improved
- when their home’s value has increased significantly
If any of these are true for you, here is what you need to know about refinancing your mortgage, and other things to consider before deciding to refinance.
When Interest Rates Drop
The interest rate a borrower can get is based on a person’s credit rating, the current federal interest rate, the term of a mortgage, and more.
The lower a federal interest rate is, the lower the interest rates offered by banks are. When banks can offer lower interest rates, people can save a lot of money on their monthly mortgage payments as well as over the life of the loan. Lower interest rates also mean people can qualify for a larger home given the same amount of income. Our mortgage calculator will show you how much you can save.
For example, if someone takes out a $250,000 mortgage with a 20-year term and a 3.92 interest rate, they would pay $1,504 per month and $111,064 in interest over the life of the loan.
However, if all else was the same and their interest rate was 3.5%, their monthly payment would be $1,450 and the total interest they would pay over 20 years would be $97,976.
This difference of nearly half a percent in interest could mean a savings of nearly $15,000 over the life of the loan that could be better spent paying on the principal of the loan. Therefore, it might make sense for homeowners to refinance at lower interest rates to put extra cash in their pocket each month and pay down their mortgage faster.
Run the numbers for your own scenario using our loan refinance calculator.
Your Credit Has Improved
Lenders base their interest rates on the risk of each loan. If you have poor credit, you may be a risky borrower and therefore receive a higher interest rate on your mortgage. However, if over the years since you took out your mortgage your credit score has increased, you might be able to refinance at a better rate and save a significant amount on your mortgage.
Your Home’s Value Has Gone Up
Another reason you might consider refinancing your home is if the value has increased. This option is especially worth considering if you have other high-interest debts that you need to pay off.
For example, let’s assume that you took out a $250,000 mortgage on a $300,000 home that is now worth $400,000. Let’s also assume that you have made several regular payments, so you now only owe $200,000. However, over the past few years, you’ve had $30,000 of unexpected expenses that you decided to cover with a credit card. In total, you would have $230,000 in debt. You can choose to refinance your home to cover the high-interest credit card debt and bring your remaining mortgage from $200,000 to $230,000 but eliminate the stressful interest-accruing payments from your credit card debt.
While this is a legitimate way to consolidate your debt and take advantage of lower interest rates, only do this if you can make the new regular payments on your mortgage. Your total debt will not decrease, but when you pay off your high-interest debt, you can save money each month by paying less total interest.
What To Consider Before Refinancing
If these reasons to refinance your home appeal to you, there are still some things that you should consider before making the leap.
There are always fees associated with closing on a property, even when refinancing. Typically, closing costs are 3-6% of the total value of the loan. If we follow the above example of taking out a new $230,000 mortgage, you can expect the closing costs to be at least $6,900.
You should take the time to consider if these fees are worth the lower monthly mortgage payment. For example, if your monthly mortgage payment is going from $1,500 to $1,400, it would take at least 70 monthly payments to cover the $6,900 in fees associated with refinancing. That’s nearly six years! So there is a break even point when it comes to refinancing, and if you don’t stay in the home long enough it would not pencil out.
Your mortgage term plays a part in determining the interest rate. Therefore, if you originally took out a mortgage with a 30-year term, you could get an even better rate by taking out a mortgage with a 20-year term. While this might raise your monthly payment, it could help you pay less over the life of your loan and become debt-free more quickly.
Refinancing can take a lot of your time. If you are already busy, it might not be worth it for you to put in several hours over the next couple of months to shop around for a mortgage, meet with your lender and lawyer, and more. Therefore, take some time to calculate if you will save money on refinancing your home, and decide if it is worth it for you.
Take time to review your credit score before you decide if you want to refinance. If your credit score is not good, or if it isn’t better than when you took out your first mortgage, it might not make sense to refinance your home.
The Bottom Line
Refinancing can be a way to save a lot of money on your mortgage each month. It can also help people enhance their financial situations, or accomplish other financial goals. However, home ownership may not be a cornerstone of the American dream like it used to be.
As with any major financial decision, it is wise to consult a financial advisor before making a final decision. They will be able to help you calculate your mortgage payments and learn how refinancing might help you reach other financial goals.