If you are looking for ways to save money, refinancing your home may feel like a no-brainer. Lowering your interest rate, shortening your loan term, and tapping into your home’s equity are just a few possible outcomes for those who choose to refinance. That doesn’t mean refinancing your mortgage doesn’t come at a cost, though. It can be difficult to determine whether the benefit of refinancing your home outweighs the expenses necessary to make it happen.
When you refinance your property, closing costs can add up to anywhere between 3% to 6% of your loan's principal amount. Appraisal fees, title insurance fees, and any additional application fees should always be factored in when you’re weighing the potential financial benefit of refinancing.
At The JL Smith Group, we believe the best choices start by asking questions, talking with experts, and doing your homework. We have pulled together a few useful tips to help you better understand what refinancing a mortgage really means, how it will affect your bottom-line, and how to get started.
What is Mortgage Refinancing and What are the Benefits?
When a homeowner decides to refinance, the process can look strikingly similar to the steps that were taken to purchase the home in the first place. This is because refinancing in essence is swapping out your old loan for a new one. Why would you do this? There are a number of reasons why someone may choose to refinance:
- Lower Monthly Payments: When market interest rates drop, refinancing to get a lower interest rate can lower your monthly mortgage payments.
- Shorter Loan Term: If you refinance from a 30-year to a 15-year mortgage, your monthly payment will most likely increase, but cutting years off your mortgage and having a shorter term means you will pay less interest over time.
- Change Loan Structure: Once the fixed period of an adjustable-rate mortgage (ARMs) ends, your interest rate may increase quite a bit. You can avoid this by switching from an ARM to a fixed-rate mortgage.
- Cash Out Home Equity: Refinancing gives individuals the option of tapping into the increased equity of their home in the form of cash-out refinance.
It is crucial that no matter the end goal, individuals who are considering refinancing take the time to conduct proper research. Ill-advised decisions can lead to unintentional consequences that can negatively impact your long-term financial situation.
When it is a Good Idea to Refinance?
The most important piece of information you will need to know to determine if refinancing is right for you is your break-even point. This is a numerical value that you can calculate to determine whether your savings from a lower interest rate will exceed your refinancing closing costs. Keep in mind, closing costs include:
- Application fees
- Title insurance and title search fees
- Attorney fees
- Origination fees
To calculate your break-even point, you will want to divide your total closing costs by the monthly savings from your new loan payment. You can also use a mortgage refinance calculator to make the process of determining your break-even point even easier.
If your savings amount does not exceed the costs, you will most likely need to consider whether refinancing is really the best option. In cases like this, it may make the most sense to stick with your existing mortgage.
Another important factor to consider when thinking about refinancing is how long you plan to stay in your home. Even if the money you save on your new loan exceeds your closing costs, it will still take you a significant amount of time to recoup those costs. If you do not plan on staying in the home long enough to recover your closing fees, you will end up losing money. On the other hand, if you have no intention of moving any time soon, recouping your costs should not be an issue.
Strategically evaluating your current financial situation, long-term goals, and future needs can be difficult. Financial Advisors are a great resource to help you wade through the scenarios and numbers to determine what is best for you and your family.
When it is a Bad Idea to Refinance?
Just like many other life choices, there are pros and cons of refinancing that should be considered before making any significant financial decisions. For one, it is important to determine whether your current mortgage comes with a prepayment penalty.
A mortgage prepayment penalty is a fee that some lenders charge when you pay all or part of your mortgage loan term off early. Lenders use this penalty, which can be upwards of thousands of dollars, to deter borrowers from paying their loan back too quickly. Why? The faster a loan is paid off, the less interest paid to the lender.
Similar to closing costs, if your prepayment penalty outweighs the amount of money you will save with a lower interest-rate loan, it may not be the best choice to refinance. Borrowers can always ask to have their penalty waived if they agree to stick with the same lender, but please note, lenders have no obligation to agree.
Another downside of refinancing that could potentially impact your decision is your credit score. Comparable to when you apply for a traditional mortgage, you will need to match or exceed a lender’s credit score requirements in order to be approved for a mortgage refinance.
If your credit score has changed since you first got your mortgage, it is important to determine whether your new score meets the typical lender requirements for a loan. If your credit is no longer high enough to meet refinancing requirements, you will need to focus on repairing your score before you can consider refinancing your home.
Lenders will also look at debt-to-income ratio, work history, and the amount of equity you have in your home. If you are unsure of where you stand, consider working with a Financial Advisor to determine your financial health before pursuing a new loan.
Who to Ask for Help Refinancing your Home.
The key take-away when it comes to refinancing your mortgage is that to determine if it is right for you, and to find the best refinancing rates, you need to do your homework. If you aren’t sure where to start, or just want a trusted advisor that can help you along the way, work with one of our Financial Advisors. At The JL Smith Group, we have the expertise and the knowledge to make sure you make the right decisions for your future. Schedule a call with us today to get started.