Mortgage refinancing gives homeowners a way to reduce their home loan interest costs, and maybe even shorten the mortgage term at the same time. As a result, it is one of the most common financial strategies among people who own homes.
This article addresses the number-one question among homeowners who are considering a refinance loan: When does it make sense for me to refinance my mortgage loan? And when is it not a good idea? Here’s what you should know about this all-important “when” question:
When Refinancing Makes Sense
There are some general rules you can use to determine whether or not a refinance loan makes sense for your situation.
1. Switching from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage loan: This is a common reason why homeowners pursue refinancing, especially given all of the negative press ARM loans received during the housing crisis and mortgage meltdown. Eventually, an ARM will adjust to a new interest rate, and the new rate might be higher than the original one assigned when the loan was originated. This is just the uncertain nature of adjustable loans. So many people use refinancing as a way to move to a more predictable fixed-rate mortgage.
2. Capitalizing on lower interest rates: This is another common reason why people refinance their home loans. When interest rates are low, homeowners with good credit and a sufficient amount of equity are often able to refinance into a lower rate. This could reduce the size of their monthly mortgage payments, as well as the total amount of interest paid over time. In fact, if you refinance into a lower rate and keep the new loan for many years, you could potentially save tens of thousands of dollars in interest costs.
The goal of both of these strategies is the same, to either (A) lower the interest rate on the loan, or (B) prevent the interest rate from rising through a mortgage adjustment. These strategies can even be combined. In 2014, when mortgage rates hovered below 5%, thousands of homeowners in the U.S. refinanced to switch from ARM to FRM loans, while also securing a lower rate in the process.
* Just keep in mind these are general rules of thumb. They might not apply to your situation. So do plenty of research and ask a lot of questions of your lender, to determine if refinancing is right for you.
It’s Not Always a Good Idea
There are some valid reasons to refinance a home loan. We discussed those reasons above. But it doesn’t always make sense.
Here’s another rule of thumb: If the money you pay to refinance the loan (closing costs) exceeds the amount of money you save over the term of the new loan (lower interest rates), then it doesn’t make sense to pursue this strategy. After all, nobody wants to pay more than they save in a financial transaction.
The key here is to think about your long-term plans. If you think you’ll be moving and selling the home within a few years, it probably doesn’t make sense to refinance. In this kind of scenario, you probably wouldn’t keep the new loan (after refinancing) long enough to recoup the fees and charges you paid on the refi. But if you plan to stay in the home for many years, you could very well reach the “break-even” point when your savings begin to exceed the initial costs.
Do the necessary research to find out what you would pay, as well as what you would save, by refinancing your home. Once you’ve determined those numbers, you will have a much easier time deciding if a refi is right for you.