When Should You Refinance?
Refinancing can be a great tool for reducing interest payments, tapping into your equity, and lowering the overall cost of your mortgage, but it’s not a miracle solution to every home owner’s problems. If you’re thinking about refinancing, take an honest look at your circumstances as well as the current financial market–refinancing can cost between 2% and 5% of a loan’s principal and requires an appraisal, title search, and application fees, all of which will come out of your pocket.
So, why refinance? Let’s look at a few reasons:
Securing a Lower Interest Rate
Lowering the interest rate on your current loan is one of the very best reasons to refinance. Reducing your interest rate not only helps you save money, but it also increases the rate at which you build equity in your home, and it can decrease the size of your monthly payment.
A general rule of thumb is that refinancing is a good idea if you can reduce your interest rate by at least 2%. When interest rates fall (as they have post-COVID), many homeowners choose to refinance their existing loan for a new loan offering a significantly shorter term without dramatically raising the monthly payment. For example, a 30-year fixed-rate mortgage on a $120,000 home, refinancing from 9% to 5.5% can cut the term to 15 years with only a slight change in the monthly payment from $805 to $817.
Converting to an ARM or Fixed-Rate Mortgage
While Adjustable-Rate Mortgages (ARMs) often start out offering lower rates than fixed-rate mortgages, the inevitable adjustment can raise your rate higher than you can get with a new fixed-rate mortgage. Not only will you enjoy a lower interest rate, you won’t have to worry about future interest rate hikes. On the other hand, refinancing from a fixed-rate loan to an ARM can be a sound financial strategy if interest rates are falling, and you don’t plan to stay in the home for more than a few years.
Refinancing to Tap Into Your Equity or Consolidate Debt
Many homeowners refinance to access the equity in their homes to cover big expenses, like remodeling, consolidating higher-interest debts, or paying for a child’s college tuition. The benefits can be real—remodeling can add value to your home, interest rates on a mortgage can be far less than interest on credit cards or other debts, and, mortgage interest is tax-deductible.
While these are valid reasons for refinancing, they can backfire if the homeowner falls back into overspending habits. It simply doesn’t make sense to spend a dollar on interest to reap a 30-cent deduction on your taxes. And it can take years to recoup the 3% to 6% of principal that refinancing costs, so don’t do it unless you plan to stay in your current home for more than a few years.
Talk your plans over with a USA Mortgage Loan Originator. They can help you evaluate your current situation and whether refinancing is the right move for you, right now. For an in-depth look at the whys, hows, and ins-and-outs of refinancing, check out USA Mortgage’s Ultimate Guide to Refinancing a Home.