If you’re a homeowner with a mortgage, then you may have heard of the advantages of refinancing. The benefits are far-ranging and include the chance to reduce your interest rate, lower your monthly payments, and the ability to tap into your equity. There’s also no limit to the number of times you can refinance. Theoretically, you could refinance immediately after closing on your loan. But like all things, there is a catch. Just because you can refinance your loan doesn’t mean you should.
Here’s a look at everything you need to know about refinancing and how you can get the most out of your loan.
What are the Benefits of Refinancing a Mortgage?What are the Benefits of Refinancing a Mortgage?
Most people chose to refinance because of one or more of the following reasons.
- A Better Interest Rate – This is the most common. A lower interest rate can lead to big savings over a long-term loan. You stand a good chance of getting a better rate if your credit score has improved significantly since you took out the loan or if rates, in general, have fallen since then.
- Lower Monthly Payments – A lower interest rate means a lower monthly payment. This can be highly advantageous if your refinanced loan has the same payoff date as your previous loan.
- More Predictable Costs – If your first loan was an ARM (adjustable-rate mortgage), then you may want to refinance to a fixed-rate loan for more predictable monthly payments. This might mean taking on a higher interest rate, but at least you’ll have the comfort of knowing it won’t go any higher.
- Shorten Your Loan Term – A common tactic for borrowers with a 30-year mortgage is to wait a few years and then refinance to a 15-year loan. Doing so can allow you to pay off your loan faster and save more interest over the loan’s lifetime.
- Borrow Money – Through cash-out refinancing, you can borrow against your equity to access funds for any purpose. This can be a great way to raise money for an emergency. Just know that the amount you borrow will be added to your mortgage principal.
- Cancel Mortgage Insurance – If your original loan came with PMI, you’d be able to refinance once you reach 20% equity. This also applies to certain FHA loans that come with PMI for the lifetime of the loan.
What are the Downsides to Refinancing?What are the Downsides to Refinancing?
While there usually isn’t any limit on the number of times you can refinance a loan, it’s unlikely you’ll do it too often as it will mean paying closing costs each time. This can add up to anywhere from 2-7% of the home’s value. In a costly market like NYC, this can add up to a hefty amount. This is why it’s important to do the math first. Work out your breakeven point and whether you stand to save more in the long run once these closing costs have been offset.
Another negative impact of multiple refinancings is that they will lower your credit score. Each time you refinance, a loan officer will have to perform a hard credit check. Since credit checks remain on your report for up to two years, too many in a short space of time can leave a lasting mark. Make sure you have a solid enough credit score to take a small hit when contemplating multiple refinancing’s in the space of 24 months.
Lastly, you need to consider how many extra years you’ll be adding to the loan by refinancing? Even if your interest rate is lower, you could still end up paying more by adding another five years to a 30-year fixed-rate loan. One solution might be to refinance with a short-term loan of 10, 15, or 20 years. This might mean taking on a higher monthly payment and means a lower interest rate that can add up to big savings in the long run.
When Is It a Good Time to Refinance?When Is It a Good Time to Refinance?
The last few years saw interest rates fall to record lows. However, they’re now on the rise again. As of this writing (28 May 2021), a 30-year fixed-rate mortgage currently sits at 2.95%, according to Freddie Mac. It can be difficult to know whether you should wait to see if they drop again or refinance now before they spiral even higher. This is a personal question that each homeowner will have to wrestle with. As a rule of thumb, if the numbers look reasonable, it’s probably a good idea to refinance.
What it really comes down to is how much you stand to save. If interest rates have dropped enough, they could reduce your monthly mortgage payments could be reduced by $50-100, then that’s a good reason to refinance. For a 30-year conventional loan, savings like that can really add up.
Should You Refinance with Your Current Lender or find a New One?Should You Refinance with Your Current Lender or find a New One?
If your primary goal is to get a lower interest rate, that may not be easy to get if you stick with your current lender. To get a good deal, it helps to shop around and see what other lenders are offering. When comparing lenders, don’t just focus on the varying interest rates. Look at all the costs involved in acquiring the loan. This includes loan fees, repayment terms, and the different loan packages on offer.
Even if you choose to refinance with your current lender, researching what else is out there can help you negotiate for a lower interest rate. Mention a competing lender’s better rate, and your current lender may try to match or beat it to keep your business. If you do go with your current lender, make sure you read the fine print to understand if the new loan comes with points. These are prepaid fees that are used to get a lower interest rate. One mortgage point typically equals 1% of the loan amount and can reduce your interest rate by 0.25%.
The best way to compare different lenders is to get multiple loan estimates. Each estimate will lay out all the costs involved in acquiring the loan to be easily compared. Keep in mind as well that switching lenders will mean more hassle and paperwork.
Final ThoughtsFinal Thoughts
Any decision to refinance your mortgage should be a well-thought-out one. Even if all the experts agree that now is a good time, it still largely depends on your own financial situation and long-term goals. For personalized advice, please talk with a financial planner and get their assessment on whether it’s a good idea or not. Refinancing comes with many risks and pitfalls and a lot of benefits for those who time it right.