Like many homeowners, our home’s value has significantly increased in the last few years. Current market conditions have caused real estate prices to skyrocket. Meanwhile, mortgage rates have hit historic lows. According to the barrage of junk mail and phone calls, many lenders insist that this is the best time to refinance your home. While we usually ignore this kind of solicitation, the rates they were advertising made it worth looking into. If you’re like us and aren’t sure if now is the right time to refinance your home, here’s what you need to know.
What Does It Mean to Refinance Your Home?
When you refinance, you pay off your existing home loan and replace it with a new one. There are a variety of different mortgage loans available to home buyers, each with its own terms and conditions. Many choose to refinance hoping to get better terms with a new loan.
However, this isn’t always a smart financial move. First, you must first qualify for a new mortgage and meet the lending requirements as you did with the original loan. This can cost anywhere from 3-6% of the principal, plus the fees for an appraisal, the title search, and the application itself. And, if your financial situation hasn’t improved, neither with the terms lenders can offer you.
So, when is it a good idea to refinance your home?
Why Do People Refinance?
While there are several valid reasons, here are the 5 of the most common reasons why you may consider refinancing.
1. You Get a Lower Interest Rate.
One of the best reasons to refinance your home would be to lower the interest rates and monthly payments. This was my primary reason for even entertaining the promotional offers. Some of the advertisements claimed to offer mortgages with as little as 1.5% APR.
If the claims weren’t too good to be true, we could save money and pay less in interest in the long run. And, it would help us build equity faster.
2. You Can Shorten the Terms of the Loan.
Another possible reason this could be beneficial for us would be to shorten the terms of the loan. If we could get a lower interest rate, we would be able to put down more towards the principal and pay the loan off faster.
Although we will probably have higher monthly payments, the savings and freedom from debt would be worthwhile. And, since we have reduced household spending, this was one option that would get us closer to our long-term financial goals.
3. You want to change to an Adjustable-Rate or a Fixed-Rate Mortage.
After discussing this with forums and friends, many people shared that they refinanced their mortgage to switch from an adjustable to a fixed-rate mortgage, or vice versa.
Some people shared that they initially liked the adjustable-rate mortgage since it had lower rates. But, fluctuations can lead to rate increases that mean you pay more than you would with a fixed-rate mortgage.
On the other hand, if interest rates are dropping, switching from a fixed-rate mortgage to an ARM is a solid financial strategy. It will continue to benefit you as long as rates continue to drop.
Either way, there may be better options for your situation.
4. You Need to Tap into your Home’s Equity.
Unfortunately, there are times when you need access to cash. Tapping into your home’s equity is one way to do this. If you choose to do a cash-out loan, you borrow more than you owe. Then, you receive a check for the difference.
Some homeowners put it back into their homes to complete expensive repairs, renovations, or updates that add value. Others use the cash to cover large expenses like education or unexpected emergencies.
Many people use it as a means to consolidate debt. Since mortgage loans offer lower interest rates than most credit cards, they use the cash-out option to pay off these high-interest debts. But, you should be cautious because this could be a slippery slope if you don’t change the behavior that got you into debt in the first place. You could find yourself in the same situation, or worse. When you calculate the cost of refinancing, the lost equity, and added interest with extra years on the loan, you may find yourself even deeper in debt.
5. You Want to Eliminate FHA Mortgage Insurance.
Finally, you may consider refinancing if you want to eliminate the FHA mortgage insurance. Although you have the option with private mortgage insurance, you usually can’t cancel insurance premiums on FHA loans. The only way to get rid of it is to refinance or sell.
Is Now the Right Time to Refinance Your Home?
Refinancing isn’t the right answer for everyone. And in this case, it isn’t the right time for us either. After checking rates, the various offers ranged from 2.3% to 3.1%. Since we’re already getting a decent rate of 2.5%, it didn’t make much sense.
According to our financial advisors, a good rule of thumb is that if you can lower your interest rates by 2% or more, it is worth refinancing. Some say a 1% reduction is enough to justify it. However, neither measure qualified us.
The only way to know if it’s the right time to refinance your home is to do the math for yourself. Before you submit the application and take a hit to your credit report, you can use online calculators to estimate what terms lenders will offer you. If you can reduce your monthly payments, shorten the length of the loan, want to build equity faster, or plan to use it to regain control of your debt, then it may be a good option for you.
You should carefully consider and discuss your options with your financial advisor before you do anything. Although the housing market has been fairly stable, it is an exception in an otherwise volatile market. There are no guarantees that you will get better terms or that refinancing is a wise financial move. So, it’s always best to get expert advice before making any life-changing decisions.
- How to Compare Rates for Mortgage Refinancing
- Would You Sell Your House With No Equity
- Refinancing Your Home Is Not Always A Good Idea
Jenny Smedra is an avid world traveler, ESL teacher, former archaeologist, and freelance writer. Choosing a life abroad had strengthened her commitment to finding ways to bring people together across language and cultural barriers. While most of her time is dedicated to either working with children, she also enjoys good friends, good food, and new adventures.