When is it a Good Idea to Refinance My Mortgage?

When is it a Good Idea to Refinance My Mortgage?

Posted: 2019-07-25 | Author: Scott Roberts

Refinancing a mortgage means taking out a new mortgage to pay off the old one. There are many reasons why a homeowner may want to do this. The most common is to save money by getting locked in at a lower interest rate than they have on their current mortgage. There are some other good reasons to consider a new refinance as well; such as switching from an adjustable to a fixed-rate mortgage, shortening the duration of a mortgage, and consolidating debt at a lower interest rate.

Refinance a mortgage will mean thousands of dollars in closing costs, so you have to make sure that it is in your best interests to move forward with this option. For example, if you are lowering your interest rate from 5.5% to 4.5%, examine how much you will save in interest and monthly payments over the term of the loan to determine how many years it will take to break even on the refinance.

These numbers can get confusing, and each individual circumstance is unique. The best way to know for sure if it is a good idea to refinance your mortgage use to speak with a local lending professional. A lending specialist who is local can sit down with you, thoroughly evaluate your situation, and go over all your options. This way, you can make the most informed decision on how you wish to proceed.

When it Might make Sense to Refinance your Mortgage

Lower your Interest Rate
As we have talked about previously, getting a better interest rate is the most common reason people decide to refinance their mortgage. But lowering your interest rate should not be the end goal in and of itself. Your ultimate goal is to save money on your mortgage costs. To determine if refinancing to a lower your interest rate makes sense, there are two important factors you should look at; how much of an interest rate savings you are getting, and how long you expect to be in the home.

To even consider refinancing your mortgage for a lower interest rate, the interest rate savings needs to be significant. Lowering your rate from 4.5% to 4.25%, for example, is not usually going to be worth it. It would most likely take decades to recoup your closing costs, and this leads us into our second point; how long you plan to stay in the home.

The average homeowner moves about every five to 7 years. Job changes, kids growing up and the need to downsize, health and financial challenges, and other circumstances necessitate moving to a different residence from time to time. Take a look at your own situation and think about how long you plan to stay in your home.

For example, if you believe you will be there another five to 10 years or more and you can save 1% or more in interest, then it is probably a good idea to refinance. On the other hand, if you are only saving about a half a percentage point and you plan on moving within the next year two, then you should probably pass on this option.

Shorten the Duration of the Mortgage
Some people look at refinancing in order to change the duration of their mortgage, usually to shorten it. For example, you have 22 years left to pay on a 30-year fixed-rate mortgage that you financed at 5%, and now you have the opportunity to refinance into a 15-year fixed-rate mortgage at 3.5% with roughly the same monthly payment. In this type of situation, it clearly seems like a good idea to refinance your mortgage, since you are paying the same amount every month and paying your mortgage off seven years sooner. Not every circumstance is this clear cut, however, and again, you need to look at your own situation to see determine if refinancing makes sense.

Convert from an Adjustable to a Fixed-Rate Mortgage
Some homeowners start out with an adjustable rate mortgage (ARM) in order to get into a home at a lower interest rate and with a more affordable monthly payment. ARMs start out with a lower rate than a fixed mortgage, but they adjust higher over time. This type of mortgage is a great option for people who only plan to own a property for a few years. Over time, however, the ARM ends up with a higher interest rate than what you can get for a fixed rate mortgage. If you have an ARM and you are planning to stay in the house for several more years, it might very well make sense to refinance and lock in a lower mortgage rate for the long term.

Tap into Equity and/or Consolidate Debt
Homeowners often consider a refinance in order to tap into the equity they have accumulated by owning their home to pay for a major expense, to consolidate higher interest debt, or both. On paper, this might seem to make sense. For example, if you have $20,000 in credit card debt with an average interest rate of 18%, you can certainly save a lot of money in interest by consolidating that debt at a much more reasonable rate like 4% or 5%.

While it might be a good idea from a cost savings standpoint to refinance your mortgage to consolidate debt, just be mindful of the fact that you will also need to make some lifestyle adjustments in order to prevent this situation from happening again. If all you do is refinance your mortgage and clear off your credit card balances, there is a danger that your credit cards will be maxed out again within a couple of years or so. Use this solution carefully and speak with your mortgage lending specialist or a qualified financial advisor about steps you can take to stay permanently free from significant credit card debt.

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