Buying your first home is exciting. The experience can also be a bit confusing when obtaining your home financing. While it may seem that the decisions about financing end at the mortgage closing, that’s not necessarily the best tactic for your finances.
A mortgage is a long-term commitment. Rather than a one-and-done transaction, it’s a commitment that’s worth frequent review to determine if a new mortgage, or “refinance,” is beneficial to you.
When you refinance a mortgage, you pay off the remaining balance on an existing home loan and take out another mortgage. There are several potential reasons for refinancing and also factors to consider before deciding you should.
Lower your monthly payment.
The most obvious reason homeowners refinance their mortgage is to take advantage of a lower interest rate. When mortgage rates drop, refinancing will reduce your monthly payment and leave you more room in your budget for other expenses or to boost your savings.
How much do rates have to drop to make it worthwhile to refinance? The rule of thumb used to be that it’s only worth refinancing if you can reduce your interest rate by at least 2%. Today, many borrowers find that even lower rate reductions can be enough of a reason to refinance.
Say you have a 30-year fixed-rate mortgage with an interest rate of 5.75% on a $200,000 home. Your payment is $1,017. If you refinance that same loan at 4.5%, your monthly payment will drop to $894.
Pay off that mortgage sooner.
Some homeowners refinance so they will finish paying off their loan sooner. If you have a mortgage with a high interest rate, refinancing can help you pay off your loan in half the time without changing your monthly payment much.
Refinancing to a shorter term usually results in a higher payment. If your income has increased since getting your mortgage and you plan to stay in your current home, that larger payment may be worth it when you consider the long-term interest savings you gain from paying down your loan sooner.
Consider this example. Suppose you have a choice between a 30-year and a 15-year mortgage for a $150,000 loan. The rate on the 30-year is 4.5%, and the rate on the 15-year offer is 4.0%.
The payments on the 30-year option are $760 per month, a total of $273,609, including $123,609 in interest paid over the term.
The 15-year option has a higher monthly payment of $1,110 - a pretty substantial increase over the 30-year option. However, if you can swing it, your payments will total $199,716, cutting your interest cost to $49,716.
If your home fits your needs for the long haul, imagine how great it would be to not have that monthly payment just 15 years from now.
But it’s not quite that easy. You may also need to consider any possible tax implications since mortgage interest can be deductible. With the recent increase in the standard deduction, the deductibility of interest may be less of a factor for many consumers.
Fix that adjustable-rate mortgage.
An Adjustable Rate Mortgage (ARM) can be a good option for many borrowers because they generally come with lower rates than fixed loans, resulting in lower monthly payments. However, over time, the interest rate will change and may result in higher payments. When this happens, switching to a fixed-rate mortgage will shelter you from future increases.
On the flip side, if interest rates are historically high and likely to fall, it can make sense to convert a fixed-rate mortgage to an ARM.
In today’s rising rate environment, it’s more likely that homeowners will be interested in switching from an ARM to a fixed rate loan.
Use the equity in your home to finance a major purchase.
Some homeowners choose a “cash out refinance.” This refi mortgage lets you tap into your home's equity to provide funds for a large purchase. You get a new, larger loan and use the difference over your old mortgage balance to fund something else. Your home must have appreciated in value, or your mortgage balance must have been paid down considerably to qualify for your new loan.
For example, say you own a home that is worth $400,000, and you owe $240,000 on the mortgage. If your lender lets you borrow up to 80% of the home’s value, you could refinance into a $320,000 loan and take out the $80,000 difference in cash.
Cash-out refinances are a good idea if you need some cash for something major and important - like a home renovation or college tuition.
How much will a refinance cost?
Refinancing is not merely a choice between terms and rates. There are costs. Remember those fees and closing costs you paid when you first bought your house? You’ll be paying most of them again if you refinance.
Before you refinance, make sure you know all of the costs and that you will be saving money. Your lender will provide you with a good faith estimate of costs. Shop a few different lenders since these costs will vary from lender to lender.
Take the total costs and divide that by the amount you will save on your monthly payment to determine how many months will have to pass before you break even on the refinance.
You may also compare the refinance cost to what you will be saving in the long run if you’re refinancing into a shorter term. You may find the refi expense acceptable when you see how much you will be saving in the long run.
One last consideration...
Before jumping into a mortgage refinance, ask yourself how long you plan to stay in your home. Even if you get a huge drop in your rate and payment, it likely won’t make sense to incur the costs of a refinance if you then decide to move in a year or two.
Should you or shouldn’t you refinance? A mortgage is a long-term commitment. Make sure you frequently review your options. Contact a Genisys Mortgage Consultant today at (248)745-3353 to arrange your mortgage checkup.
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