As interest rates remain higher than they were just a year ago, you may be wondering if now is still a good time to refinance. Good question.
The purpose of a refinance is to replace your existing mortgage loan with a new one. There are many benefits of a refinance and it doesn’t only involve reducing your interest rate. It’s also helpful for homeowners who want to drop their private mortgage insurance (PMI), change their loan term or other factors.
Refinancing isn’t beneficial for everyone. It depends on your specific financial situation. If you believe you’d benefit from a mortgage refinance, then start by answering a few simple questions to see how much you could potentially save.
Here’s what you need to know in order to plan your mortgage refinance just right.
When is the best time to refinance your mortgage?
There’s no set rule for when you should refinance. It depends on your budget, plans as a homeowner and goals. Are you looking to lower your rate or payment? Do you want to pay off your loan faster? A mortgage refinance could allow you to do both.
Here are some guidelines for when refinancing might be smart:
- You can reduce your interest rate by 1% or more: Check Freddie Mac’s weekly rate updates and compare those rates to your own. Most experts say refinancing is worth it if you can lower your rate by at least one percentage point. In some cases, a half-point may be beneficial — especially on larger loan amounts (when even a fraction of a percentage can make a big difference in long-term costs).
- You plan to be in the home long enough to reap the benefits: To determine if refinancing is worth it, calculate your breakeven point — or the month when you’ll recoup your closing costs. If your refinance costs $5,000, for example, and it saves you $150 per month, your breakeven point would be around 33 months (5,000/150). If you plan to be in the house for at least 33 more months, then refinancing is probably worth the money.
- You need cash and would likely need to put expenses on a high-APR credit card without it: If you’re facing upcoming expenses that would otherwise go on a credit card, you might consider a cash-out refinance instead. Mortgage loans (refinances included) tend to have much lower interest rates than credit cards and other financial products, so this strategy can usually save you in long-term interest. Many homeowners also use cash-out refinances to consolidate their credit cards and other debts — essentially rolling them all into a single loan payment.
By answering a few simple questions you can determine if a mortgage refinance makes sense for you. Or use the table below to crunch the numbers.
If you do opt to refinance, consider doing it toward the end of the month. This will reduce your closing costs since you will only need to pre-pay interest for a couple of days. You might also consider refinancing toward the end of a quarter, when mortgage lenders may be looking to meet quota (and potentially offer better deals to do so).
When should you avoid a mortgage refinance?
While refinancing your mortgage sounds good in theory, you need to make sure you’re a good candidate for one. In this case, timing and the current state of your personal finances are key.
Here are some guidelines for when refinancing might not be the best idea:
- You just bought the house: It’s usually not wise to refinance right after you buy a home. That’s because you’re paying closing costs twice (which extends that breakeven point) and because some lenders charge prepayment fees. These essentially penalize you for paying off your mortgage loan too early.
- You can’t secure a lower interest rate: Refinancing might also be ill-advised if you’d be trading a low-interest rate for a much higher one. While there are some scenarios when it might make sense, increasing your interest rate will only add to your monthly costs and increase your interest charges in the long run.
- You have a low credit score: You probably won’t want to refinance if you have a low credit score. Low scores generally equal higher interest rates, which could reduce the savings a refinance could offer you. Generally speaking, mortgage lenders reserve their best interest rates for borrowers with scores above 740. There are ways, however, to improve your score.
If you’re not sure what rate you’d qualify for, use an online tool to find out now.
3 things to consider before refinancing
Before you consider a refinance, it’s important to keep a few things in mind.
- Closing costs: You’ll have to pay closing costs. Freddie Mac estimates these run around $5,000 per loan, but the exact total will depend on your lender, loan amount and location. You can also roll these costs into your loan and pay them off over time, just remember: It will mean a higher loan amount, monthly payment and long-term interest costs.
- Credit score: Refinancing can also hurt your credit score — at least temporarily. That’s because your lender will do a hard credit inquiry when processing your application. This causes a temporary decline (usually five points max) in your score. As long as you make your payments on time, though, the score should recover fairly quickly.
- Reverse mortgage: If a traditional mortgage refinance or cash-out refinance doesn’t sound like something you may benefit from, a reverse mortgage is also worth considering. A reverse mortgage allows homeowners (62 and older) who have fully paid or paid off most of their mortgage, to take out a portion of their home’s equity. The freed-up equity, considered tax-free income, can help pay debt, bills or complete home repairs. It needs to be repaid, however, if the homeowner dies or elects to sell the home. Make sure you know the pros and cons of this alternative before proceeding. If you think you would benefit from a reverse mortgage, you can take the first step today by seeing what you qualify for.
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