If you’re a homeowners looking to lower your monthly mortgage payment and get a better interest rate, you may be considering refinancing your home. While refinancing your mortgage can reduce costs, it may not be the best option for many homeowners. Your current financial situation, career status, and plans for the future will all have an impact on your decision to refinance.
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When Refinancing Your Home Makes Sense
The rule of thumb is that a mortgage refinance is generally only a slam dunk when you can lower your interest rate by two percentage points or more and if you plan to stay in your home for as long as it takes you be compensated for the cost of refinancing (learn how to calculate your payback period). For instance, if your mortgage payment drops by $250 a month and after adding in the cost of closing it takes you 24 months to start seeing the savings (a realistic number), you’ll need to stay in your home for at least 2 years to make refinancing worth the trouble. If you are planning to sell your home sooner than that, refinancing is not a wise financial move.
What To Look For In a Mortgage Refinance
First, you have to be realistic about where you stand financially. Do you have a steady income? Enough cash to cover closing costs? Decent credit? You will definitely want to check your credit report (find out how to get a free annual credit report) and order a copy of your credit score (I suggest using myFico.com for your score, but skip the credit monitoring services) to make sure you’re eligible for the best rates on a refinance loan. If your credit is not 720 or better, you should work on improving it before applying for a new loan.
If your credit is up to snuff, you’ll need to begin researching loan options. Never choose a loan based solely on the interest rate. There are many factors to consider including:
The length of time it will take to pay off the principal and interest of the loan is probably the most important decision you will make (see 15- vs 30-year mortgages). Mortgages with shorter terms will carry the lowest interest rates but higher monthly payments. The pro of a shorter term is a lower total amount of interest paid over the life of the loan.
Mortgage Interest Rate
Mortgages come with either a fixed- or a adjustable-rate flavors. A fixed rate, of course, means the rate is fixed over the life of the loan and will never change. Adjustable rate mortgages generally come with a fixed teaser rate for a pre-determined period of time, usually 3 to 5 years, after which the interest rate floats up and down depending on prevailing economic conditions. If you plan to remain in your home for a while, it’s usually best to stick with a fixed rate mortgage, as adjustable rates can and do jump dramatically over the coming years.
Mortgage Points Required
A mortgage point is equal to 1% of the total value of a mortgage loan. To pay points on a mortgage is to pay 1% of the mortgage up-front at closing as a way to “buy down” the interest rate. In exchange for getting some of their money up-front, most banks will agree to lower your interest rate somewhat in return. Zero point mortgages do not have an up-front fee but can end up being more costly over the long run if it means paying a much higher interest rates instead. You’ll need to calculate of a lower rate will justify the points costs. Determining whether or not it’s in your best interests to pay points on a mortgage is simple math and depends primarily on the size of the interest rate discount and how long you plan to stay in your home.
You’ll want to shop around to find which mortgage offers will be most beneficial to you. When you do find a loan you’d like to apply for, be sure to know what you are signing. Read the contract thoroughly and be certain the savings over time will outweigh the expense of a refinance. Do not feel pressed to make a quick decision. Refinancing a mortgage is generally be less time-consuming than the initial loan because most of the relevant financial information is readily available. Whatever you do, don’t make the mistake of jumping on the first refinance offer you come across without considering the alternatives.