When mortgage rates drop, you might consider refinancing to lower your monthly payment. That’s a smart move in most cases, but it’s not an easy process. In fact, refinancing your mortgage is similar to taking out installment loans for the first time.
If the rate gap is wide enough and you plan to stay in your house for a time, refinancing might be worth the trouble, especially if you can substantially lower your bill. That said, there are a few things to keep in mind when considering a refinance for your mortgage.
Refinancing Is Not Free
Refinancing costs money because it isn’t as simple as asking your financial institution for a new rate and having them give it to you. The bank has to issue a whole new loan.
When you bought your house, you had to pay for closing costs, which included inspection fees, application fees, appraisals, commissions, taxes, points, insurance, and warranties. When you refinance, you’ll also have closing costs similar to when you took out your original loan. These costs typically run between 2% and 5% of your requested loan amount.
Before you panic, keep in mind that you can roll your closing costs into the loan itself, so you may not have to pay them out of pocket.
On the other hand, some banks offer refinances with no closing costs at all. But to get that advantage, the bank will give you a higher interest rate, which might defeat the whole purpose of refinancing.
Do a Quick Calculation
Before you refinance, you want to do some math to see if you’ll actually save money in the long run. To figure this out, you need to decide how long you plan to live in your home. If you want to move in the next few years, you might not recoup the cost of refinancing before you leave.
For example, say your current mortgage payment is $2,000, and refinancing brings it down to $1,800, but your refinance costs you $6,000. To recoup the money it took to refinance your loan, you would have to stay in your home for at least 30 months. However, if the refinance brings your payment down to $1,500, you only have to stay in your house for a year to make the cost worth your while.
So, calculate how long it will take you to benefit from your refinance and decide based on that factor.
Resetting the Clock
When you first started paying your mortgage, most of your payment went toward the interest and not your loan’s principal. But once you have your loan for years, the tables slowly turn, and you begin to pay into the principal, which lowers your overall loan amount.
Refinancing changes your current scenario back to what it was when you first took your loan, and you’ll pay into the interest first again. Before refinancing, ask your lender for a side-by-side comparison of your current loan and the refinanced loan. Using that information, see if you’re happy with the pace of your new loan paydown before making a refinancing decision.
Refinance for Those Better Rates
When you see the Federal Reserve lowering interest rates, you might decide it’s time to refinance your home. The truth is, you might be right. But before you make your final decision, ask yourself some questions and calculate the real cost to you. If you’re happy with the answers, talk to a lender about the possibility because it never hurts to ask, and you just might save yourself big bucks on your monthly bill.