Over the past couple of months, you’ve probably seen a myriad of TV ads and received countless offers in the mail encouraging you to refinance your mortgage. Many of these ads serve up grand claims like, “The best time to refinance is now!” or “Refinance today to save thousands!”
While some of these offers are likely too good to be true, there is at least some truth behind all of them. Because the Federal Reserve recently decided to buy up mortgage-backed securities, mortgage rates have fallen in recent months—and lower mortgage rates translate into potentially rewarding opportunities for some homeowners.
However, because every homeowner faces their own unique situation, refinancing may be the right answer for some families but the wrong move for others. So, before you dial the 800 number on that refinancing ad and sign on the dotted line, take some time to ask yourself the following important questions.
Does it make sense for me to refinance right now?
Believe it or not, the answer to this question involves much more than just mortgage rates. It really comes down to your particular situation.
When you refinance, you’re basically starting from scratch and applying for a new loan. You may choose to sign a new contract with your original home mortgage lender or work with a new lender. Either way, your new home loan will pay off the old loan, and you’ll make payments according to the terms of the new loan.
Here are a few scenarios when it might make sense for you to refinance:
- You can get a lower interest rate.
- A new loan will lower your monthly payment.
- You can shorten the term of the mortgage, which will allow you to build equity faster.
- You have an opportunity to switch from an adjustable rate to a fixed-rate mortgage.
What it comes down to is this: if refinancing will save you money in the long run (even if you just secured a new mortgage), you should strongly consider it.
How do I figure out if refinancing will save me some green?
First, you’ll need to determine how much it will cost you to secure the new loan. Refinancing generally costs around 2 to 3% of the total loan amount. Therefore, you should first calculate at what point you would break even.
Here’s how:
- First, figure out the monthly savings you would receive from refinancing. Ask your loan officer or mortgage broker what rate you’ll likely qualify for and what the estimated principal and interest payment will be with the new loan. Compare that to the monthly principal and interest you currently pay. (Don’t use your total mortgage payment, which probably includes property tax and insurance. Your current mortgage bill is likely itemized so that you can look at just the principal and interest payments.) This will give you your expected monthly savings.
- Next, divide the refinancing mortgage fees you’ll have to pay by the projected monthly savings. The resulting number will show you how many months it will take for you to break even.
Let’s say you discover that it will take you a year and a half to break even. If you plan on selling your home within two years, refinancing probably isn’t a good move. However, if you plan to stay in your home for many more years, you should probably consider refinancing.
What if I owe more than my house is worth?
This is called being “upside down” in your mortgage. Refinancing is probably not the ideal option for homeowners in this situation. That’s because you’d probably have to pay the difference between what you owe and what the refinancing lender is willing to lend you.
If you have the funds to pay this difference and you plan on staying in your home for many more years, then refinancing may be a good choice. However, most homeowners don’t have this kind of cash on hand.
Of course, the worst thing you can do is walk away from your home altogether. Try to avoid foreclosure at all costs. If you find yourself in this kind of quandary, you may want to meet with an attorney to discuss your options.
There’s no doubt that the current low mortgage rates could present some valuable opportunities for some homeowners. However, there are many factors involved when it comes to determining whether or not you should refinance. Before you rush out to refinance, you may want to discuss your unique situation with your financial advisor.