Step 1: Should I Refinance
You may be looking to save money, lower your monthly payment or take advantage of the equity in your home to get cash out. Below is some information to help you decide whether a refinance is the right option for you.
Examples of Good and Bad Times to Refinance
You may want to consider refinancing if you can do the following:
- Reduce your monthly payments.
There are a number of ways to do this, like getting a loan with a lower Annual Percentage Rate. The other common way to decrease your monthly payment is by extending the term of your loan from 15
or 20 years to 30 years. Lengthening your term may reduce your monthly payment; however, you will be paying more interest in the long run.
- Take advantage of a lower rate.
A general guideline is the 2% rule. If an interest rate is available that is 2% lower than your current rate, it may be a good idea to refinance. However, when you refinance, you will have new
costs associated with that loan. You will need to compare those new costs with what you will save to determine whether it’s an advantageous decision.
- Convert an ARM to a Fixed Rate mortgage.
Adjustable Rate Mortgages can be a good option if you need a lower payment at the beginning of your loan. However, monthly payments can change dependent on current market conditions. By
refinancing to a Fixed Rate loan, you’ll achieve the stability of a consistent, known payment for the entire term of your mortgage.
- Reduce your term from a 30 year loan to a 20 or 15 year loan to save money on interest.
Although your monthly payments will increase, you will save money in interest with a shorter-term loan versus a longer-term loan.
- Save money by consolidating a 1st and 2nd mortgage into a single loan.
In some cases, the monthly mortgage on the consolidated loan may be lower than your combined payments.
- Use the equity in your home to access cash.
You may opt to pay off high-interest credit cards, make home improvements or pay for your child's education using your home's equity. Equity is the dollar value difference between what
you owe and the home value of your property. When you refinance for an amount that is more than what you owe on your home, you can get the difference paid to you in cash, known as a cash-out refinance. It's important to note that when you take
out equity, you own less of your home and it will take time to build your equity back up.
A refinance may not be the best option in these scenarios:
- If you are almost finished paying off your first mortgage.
A refinance gets less and less advantageous the more mature your loan is and the more you’ve paid off. If you have a 15 year loan, and you only have 2 more
years left before you pay off your mortgage, do not refinance. A refinance will result in the loss of equity and will also add more debt to your plate – something you don’t want to do when you’re so close to paying off your home
- If you have a 2nd mortgage or a Home Equity Loan.
When you take out a 2nd mortgage or have a Home Equity Loan, you have already diminished your home’s equity. An advantageous refinance at that point is unlikely.
- If you are planning on moving soon.
There's something called a break-even period. When you refinance, you end up paying closing costs, just like you did with your first mortgage. Your refinance should eventually off-set the additional
costs you paid to close on your new loan. For example, if your closing costs were $1000 and you save $100 a month with your new interest rate, it will take you $1000 / $100 = 10 months to break even. If you don’t plan on being in your home
for 10+ months, then you should not refinance.
- If your property value has decreased significantly.
For example, if you wanted to refinance 80% of the appraised value of your home, if your property goes down in value, your current mortgage may be higher than the amount you
borrow. Your refinanced loan will not be enough to pay down your current mortgage.
6 Big Factors to Consider When Refinancing
Even though the loan process is similar to a first mortgage, refinancing is different than buying a home. Usually, people need a mortgage if they want to purchase a house. Refinancing really only makes sense if it's of benefit to the homeowner - a way
to save money. That's why research is really important when refinancing.
Top Factors to Consider:
- How long you plan on living in your home. Know your break-even period.
There's something called a break-even period you need to take into account. When you refinance, there are costs very similar to when you signed for your first
mortgage. When your refinance savings exceed the costs of your refinance closing - that's the break-even period. If it takes 5 years to reach that point and you're not planning on being in your home for 5 more years, it does not make sense to
refinance. You will move before you realize the savings of your new mortgage.
- What your refinance Annual Percentage Rate will be.
See our Daily Rates.
- What your current APR is.
- How much will it cost to close on your new loan?
For an estimated figure, your refinancing fees may total between 3% to 6% of your principal balance - what you still owe on your first mortgage.
- Check your credit score.
These are just general guidelines, but a score of 740 or higher will usually qualify you for the best rates and lowest fees. You may still be able to qualify for a refinance with a score of 680 and above,
but the interest rates and fees may not be as favorable.
- Know where you stand with equity.
If you owe too much more than what your property is worth, you probably won't be able to qualify for a refinance. That's where equity comes into play, which is the difference between what you
owe and your home's current market value.
A traditional rule of thumb is that homeowners need an 80% loan to value ratio (LTV) to qualify for a refinance. However, there may be new solutions available where you can have an LTV ratio
that is much higher.
How to calculate your loan-to-value ratio:
- Find out your home's market value.
Let's use $200,000 (Even if you bought the house 4 years ago for $250,000, use the current value.)
- Find out the balance of your existing mortgage.
Your original mortgage was for $250,000, and you have paid $90,000 already, so your principal balance is $160,000 - what you still owe from your first loan.
- Then divide the balance of your original loan by your home value to get your loan to value ratio (LTV).
Your LTV ratio would be 80% ($160,000 / $200,000) indicating you have just enough equity in your home that you may qualify
for a refinance.