You may be considering refinancing your home to save money short-term or long-term or gain control over your mortgage in another way. But, is this the right time to refinance or not?[cite::219::cite]
Assessing these criteria and understanding the process will help you be confident that refinancing will achieve your goals before you undergo the long and often intensive process.
What Is Mortgage Refinancing?
When you have a first mortgage, you’ll pay off and replace it with a new mortgage that provides you advantages the current one doesn’t. This is called “refinancing” a mortgage.
You’re getting another mortgage, a new long-term installment loan secured by your house as collateral. It’s repayable over a fixed period, usually 15 or 30 years, at specific monthly payment amounts with interest included.
What Components of a Mortgage Can Refinancing Change?
Often, it’s one of these standard mortgage components borrowers want to change to save money on the mortgage by refinancing:
- Annual percentage rate, or APR. Refinancing to lower your APR, which is your interest rate plus associated costs of the borrowing money, can reduce monthly payments
- Mortgage type. Refinancing from an adjustable-rate mortgage or ARM, where interest rates fluctuate, to a fixed-rate means fixed monthly payments rather than variable payments that could increase over time
- Mortgage size or principal amount. The amount of new the mortgage you take when you refinance
- Loan term. The period over which you decide to repay the mortgage, expressed in years
- Monthly payments. Often called PITI (“pee-eye-tee-eye”), which stands for “principal, interest, taxes, and insurance”. Refinancing can change the principal and interest on your mortgage
- Borrowers on the mortgage. If you’re adding or removing borrowers, such as a new spouse after a recent marriage, refinancing might be necessary
What Factors Matter Most when Considering Refinancing?
Refinancing requires weighing these factors carefully to determine whether this option works for you:
- Current interest rate. If you’ll save money long-term by reducing your current interest rate and converting an ARM to a fixed rate, refinancing is a good option
- Home equity. Banks usually require you have 20% equity in your home for refinancing, but it can vary by loan type, so calculate the amount you have in advance
- Credit score. If yours has improved, refinancing may significantly reduce your interest rate, and therefore, your monthly payments. But determine if you qualify first, because applying decreases your credit score
- Mortgage type. A jumbo loan you’ve paid the balance down to under $417,000 might qualify for a regular refinance at a lower rate and save you money. Adjustable rate or balloon mortgages may also qualify
- Closing costs. Know what these will be, how you’ll cover them (out-of-pocket or financing in your new mortgage), and if you’ll recoup them before moving forward
- Length of intended stay. If you’ll stay long enough to recoup closing costs you paid up-front or financed on a new loan, and that still gave you a much lower rate than you had, then refinancing might make sense
- Mortgage prepayment penalty. If you have this penalty period active on your current mortgage or will accept one on a new loan for a lower rate but won’t stay throughout the prepayment penalty period, avoid refinancing
- Mortgage term. It’s a good idea to try choosing a new mortgage term only as long as it would have taken you to repay the original mortgage, so you’re not paying more for longer. It’s even better to get a shorter term from 30 to 15 years that reduces both your payment and interest rate with only a slight monthly payment increase
Shop for the best mortgage deals, rates, and terms before you refinance.
When Should I Not Refinance?
If you’ve refinanced in the past to tap out equity, fund your lifestyle, or pay off substantial credit card and other unsecured debt, you should avoid refinancing again for this purpose.
You’re putting yourself in a vicious debt cycle that could potentially lead to bankruptcy.
Summing It Up
If done properly, a mortgage refinance can save you money and help you pay off your home faster. But, if used poorly, you could be headed toward financial troubles and even bankruptcy. It's best to understand all the key concerns and points listed above before you move forward with refinancing your home.