Should I Refinance?
Knowing whether it’s a smart move to refinance can make a huge different on your monthly spend.
“Should I save thousands of dollars?” That is the real question. Imagine yourself after you have refinanced. You’re sitting in your favorite spot in your home, with your favorite people around you, with extra cash in your pocket. After it’s all said and done, the real question is going to be, “What should I do with the money I’m saving?”. I’m sure you won’t need help with that question. Refinancing can get a bit tricky sometimes, done incorrectly could cost you thousands more than you had originally intended. These 6 tips will help you determine whether a refinance is right for you.
Should I save thousands of $$$?
When Should I Refinance?
The decision to refinance typically boils down to your reasons for refinancing. What financial goal do you have in mind for the loan, and what do you need done to the terms? Most refinances are done to achieve one or more of the following…
1. Lower the interest rate or mortgage payment.
This is the most appealing upside to refinancing. When you refinance you get a new loan with a new interest rate. When interest rates are low many homeowners refinance because if the rate can be reduced even one percent, you can save thousands by the time you pay off the loan. A plus side to a lower interest rate is that the mortgage payment often follows suit and you may see that drop as well. If you know that a refinance will considerably lower your interest rate, it would be worth your time to get a few quotes.
2. Consolidate debt or cash out equity.
Refinances are great if you want to consolidate your debt and get all of your bills rolled into one loan. In order to consolidate, you do have to have equity. When refinancing, the loan you secure will be the home mortgage plus your additional debt. Once the refinance is complete, you will use the money from the loan to pay off your debt, leaving you with only the home mortgage. Consolidating your debt is similar to cashing out equity – both of them increase the home mortgage while giving you access to the funds. When you cash out the equity, however, you can put it wherever you choose. Many homeowners like to use it for investments. The upside to cashing out or consolidating is that you can often get access to thousands of dollars while securing a low, fixed interest rate. The downside is that taking advantage of your equity increases your home loan. If you lose your job or come into bad times, it may be more difficult for you to make the payments on the larger loan. So keep that in mind when you choose a refinance for debt consolidation or to cash out the equity.
3. Switch the loan type.
When you’re locked into a thirty year loan you want to know that the interest rate you’ve acquired will be the same ten years from now as it is today. However, many homeowners secure their homes using ARM loans, which are a great option initially, but carry some risk over time. With an ARM loan the interest rate will adjust with the market trends, which means you may pay a low-interest rate one month and see it spike dramatically the next. Oftentimes homeowners will refinance to secure a fixed rate loan, especially when the interest rates are low. Low interest rates are a perfect time to refinance to a fixed mortgage. The fixed option means that regardless of the market fluctuations, your interest rate will not change unless you refinance to a new rate. Along these same lines, some homeowners will switch from an ARM to an ARM loan, again trying to secure lower rates. Again, this can be a smart move. However, if you intend to stay in the home long-term a fixed rate mortgage is less risky, but if you know you’ll be selling the home within a couple of years, an ARM loan can help you save a lot of money.
4. Adjusting the Loan Term.
When considering a refinance, many people do so because they want to shorten the loan term. A thirty year loan may sound good initially, but if you can reduce that to a twenty or fifteen year term, you can potentially save thousands. Basically, shaving off fifteen years of payments takes off fifteen years of interest as well. Reducing the loan term isn’t a guaranteed way to save money, but it is worth the time it takes to get some quotes because of the potential payoff. Keep in mind that a shorter loan term does mean higher mortgage payments, so only do this if you know you can handle the increased demands of the loan.
When You Should Not Refinance
5. You’ve had your loan for over 15 years.
This really only counts if your rate is within 1/2 a % of current interest rates although for the most part, refinances are beneficial near the beginning of a loan when you’ve only been locked in for a several years. Interest on a home mortgage is amortized in such a way that you end up paying more at the beginning of the loan term than you do at the end. For the first few years the larger portion of your mortgage payment goes on interest. Eventually though you will start paying more on principle. If you refinance late in the loan term your amortization schedule starts over and you’re back to paying down interest. Refinancing at this point may not save you money; in fact, you could lose money in the long run.
6. Prepayment Penalty
Before the mortgage industry tanked, this was a big issues, although now regulations have become very tight in this arena… Sometimes lenders will tack on a prepayment penalty so if you pay off the loan early you’ll end up paying this fee. When you refinance you pay off the first loan and the prepayment penalty will become due. The amount is determined by your lender, but in many cases the penalty will offset the potential benefits, at which point it’s not worth it to refinance. Prepayment penalties need to be considered before you refinance.
Deciding whether or not you want to refinance is going to come down to the pros and the cons. Do the financial benefits outweigh the up-front costs and/or the prepayment penalties? Will you save money monthly and over the life of the loan? Can you use your equity to make money through other investments? Getting clear on your needs is your first step. From there you can find a refinance that will get those needs met.