Should you refinance your home?
Shontel Lawrence has always been savvy when it comes to interest rates. In 2018, when her landlord gave her the option to buy the condo she had been renting, she decided to hold off on the purchase and wait for mortgage rates to drop.
Lawrence kept her eye on interest rates for over a year. When they decreased in late 2019, she pulled the trigger and bought her condo with a 30-year mortgage at 4.1%. Lawrence continued to check on interest rates, though, and saw them drop even further in early 2020, leaving her to wonder if she acted too soon.
Then the COVID-19 pandemic hit, and with mortgage rates on the decline again, Lawrence, who was less than a year into her loan, decided to refinance.
How to tell if refinancing is right for you
With mortgage interest rates at historic lows, you, like Lawrence and many homeowners, may be wondering if you should refinance. Is it just chatter, or does refinancing your home make sense for you? Here are some factors to consider.
1. You’re paying a high interest rate
If market rates were significantly higher when you first got your mortgage or your credit score has improved, it may be a good time to check the rates to see if you can refinance to earn a lower interest rate.
Lawrence, who is in the process of finalizing her refinance, will go from 4.1% to 2.3%. And her monthly payment will drop from $1,175 to $803, a $372 difference, which she plans to funnel toward her credit card debt. If Lawrence stays in the home for the entire 30 years, that’s $133,920 in savings.
2. You want to get rid of private mortgage insurance
Borrowers with conventional loans who put less than 20% down likely pay for private mortgage insurance (PMI).
If home values have increased since your purchase or you’ve made enough payments and are approaching 20% equity, refinancing could drop PMI from your loan. Even if you’re not at 20% equity, refinancing may lower the amount of PMI you pay.
3. You want to change from a variable interest rate to fixed
If you have an adjustable-rate mortgage, you might want to take advantage of this time to convert it to a fixed-rate loan. Depending on the terms of your mortgage, you may have already benefited from the recent rate decreases. But this could also be an excellent time to lock in a low rate and protect yourself against future increases.
4. You want to tap into your home equity
Many homeowners choose to use home equity to fund home improvement projects, pay off high-interest debt, or make large purchases. If you were considering borrowing against your home in the future, striking while rates are at record lows may make sense.
You can opt for a cash-out refinance and walk away with cash-in-hand — up to the difference between what you owe and 80% of your home’s value. (VA cash-out refinances permit borrowing up to 90%). Just keep in mind that interest rates on cash-out refinances are typically higher than on straightforward refinances.
Other options to tap into your home equity include taking out a home equity loan or home equity line of credit (HELOC). Regardless of which path you consider, make sure you’re aware of the risks of tapping into home equity. Drawbacks include losing your home if you’re unable to keep up with the payments, potentially increasing your total debt and extending the amount of time it will take to pay off your mortgage.
5. You can afford the cost of the refinance
Expect to pay between 2% and 6% of the loan amount in closing costs on a refinance. And homeowners who refinance conventional loans will have an additional charge after September 1, 2020. In light of the current economy, both Fannie Mae and Freddie Mac, government-sponsored enterprises, recently introduced a new refinance fee to offset potential lending risks. With this fee, borrowers pay an additional 0.5% of their loan amount when refinancing. For example, a homeowner with a $200,000 loan will have to pay an additional $1,000.
With some loan options or a no-closing cost refinance, you may be able to roll the refinance fees into the loan. Lawrence, a retired veteran from Clarksville, Tennessee, refinanced her home with a VA interest rate reduction refinance loan (VA IRRRL) and took advantage of that option.
Even if you’re not paying out-of-pocket, you should be aware of the total cost of your refinance and consider the additional interest you’ll be paying.
6. You know you’ll be able to break even
To see if the expense of the refinance is worth it, you should figure out your break-even point — how long it will take to recoup the refinance cost. To figure yours out, take the total cost of the refinance and divide it by the amount you’ll be saving on your mortgage payment each month.
Lawrence’s refinance on her $206,500 loan adds up to $6,074. Since she’s saving $372 a month with her new payment, she’ll break even in roughly 16 months (not taking taxes, interest, or other factors into consideration). Lawrence plans to stay in her home for the foreseeable future, so the long-term savings outweigh the refinance cost. But if, for example, she had a potential move on the near horizon, it probably wouldn’t have made sense to refinance.
7. You want a shorter term
You could leverage today’s low rates to refinance your loan into a shorter term. For example, you could go from a 30-year mortgage to a 15-year mortgage. And since interest rates are lower for shorter terms, you’ll also get a more competitive interest rate.
Depending on your loan’s current terms, you may be able to get a shorter term without paying too much more than you’re paying now.
If you’re not looking for a shorter term, still be wary of restarting the clock on your mortgage. If you’re five years into a 30-year loan and choose to refinance, consider a 25-year mortgage, which perseveres the progress you’ve made on your mortgage rather than restarting the clock.
8. You want to change your mortgage type or improve terms
Refinancing now may be a good idea if you have less-than-ideal terms on your loan. For example, you could get rid of a balloon payment, combine two mortgages, move from seller-financing, or go from a government loan to a conventional loan.
9. You need to offset an income reduction or other financial hardship
If you’re experiencing financial hardship and need to reduce your monthly expenses, refinancing to a smaller payment could free up some funds. Of course, depending on your circumstance, it may be harder to qualify for a refinance. But some loan options, such as the VA IRRRL and FHA streamline refinance, don’t consider income.
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