When Is a Good Time to Refinance Your Home?
When interest rates drop, your first instinct may be to refinance. At the beginning of March 2020, the average interest rate for a 30-year, fixed-rate mortgage hit its lowest level in 50 years at 3.29%. It has many homeowners wondering, should I refinance my home?
To answer the question, you’ll need to do some math. Most finance experts advise you to lock in a rate that’s at least 0.5% lower than your current rate to make a refinance worth it. But refinancing isn’t as straightforward as simply locking in a new, lower interest rate. You’re taking on a new loan, and new loans come with closing costs. Expect to pay 2 to 5 percent of the loan’s principal to refinance, says Investopedia, with fees varying by state and lender. The general rule of thumb is you should be able to recoup closing costs within 18 months.
Does a Refinance Make Financial Sense?
To answer this, you’ll want to take into account all the variables of your situation. If you shorten your loan term, will you pay less interest in the long run? If you trade one 30-year mortgage for another, will you pay more interest in the long run? Can you afford the monthly payment? Can you switch from a potentially volatile variable interest rate to a fixed rate that helps you budget more effectively? Can you eliminate private mortgage insurance (PMI)? How long do you plan to stay in your home before selling?
As an example, let’s say you bought a home in 2009 that’s currently valued at $300,000. Your initial 30-year mortgage was for $275,000 at a 4.25% interest rate. That leaves $211,382 left to pay off at $1,495 per month (factor in more if you’re paying PMI).
In scenario B, due to the length of the loan, you stand to pay more in interest. If you plan to move between years five and thirteen, you could save a few hundred dollars, but the hassle of refinancing is likely not worth the savings.
Opting for a 15-year loan over a 30-year loan in this scenario would increase your monthly payments to $1,553, but you could save nearly $12,000 over the lifetime of the loan, making it a slightly more attractive refinancing scenario. You’d recoup your refinancing costs around year three.
The SmartAsset Refinance Calculator is a great tool for homeowners to see when it may make sense to refinance their homes based on the home’s current value and mortgage.
Your Alternatives to Refinancing
With refinancing, you’re taking out a new loan for the remaining value that you owe on your home, ideally reducing the amount you have to pay each month, the amount of time left to pay the loan, or both.
But with a cash-out refinance, you’re taking out a new loan that’s greater than the amount you owe on your home, giving you additional cash to cover other expenses you may have, such as credit card debt or paying for an education.
But, if you don’t want a larger loan and potentially even larger monthly payments, you also have non-loan options. Home equity investments allow you to access cash now in exchange for a share of the future value of your home. Since it’s an investment, not a loan, home equity investments don’t have monthly payments or interest.
Home equity investments may make even more sense for homeowners looking to sell within the next decade, or before they can realize any savings from a refinance. A refinance can extend the lifetime of your loan. If you had 20 years left on your mortgage, and you refinance with a 30-year mortgage, you’ve 10 additional years of monthly payments and interest).
The best option for you will depend on a number of factors, including your home, credit score, and other variables. But it also depends on your other financial goals. What do you hope to do with your savings from a refinance? Do you need cash now to achieve another financial goal, such as pay off bad debt or start a business? Do the math, weigh all your options, and determine which scenario is best for you.
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The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, consult with a licensed advisor.