As tempting as current interest rates are, you may want to refinance your home to a lower rate. Here are five questions you should answer before you take the leap.
1. How long do you plan to stay in the home?
It makes a big difference in recouping the cost of refinancing a home loan. If you don't plan to own the home for roughly three to five years or more after refinancing, it might not make sense to incur the costs of refinancing.
2. What are the closing or settlement costs for refinancing?
You should expect to pay about the same amount as when you purchased. Expenses will include a new title policy or abstract, a new appraisal, and lender's fees.
Typically, lenders charge an origination fee or a "discount fee". If it's a "no-cost" refinance, there's really no such thing - the fee will actually be rolled into a higher interest rate. Count on your closing costs to be similar to what you paid when you originated your first loan. In other words, it's a new loan, with all-new fees.
3. What percentage rate are you currently paying?
Once upon a time, mortgage lenders advised refinancing only if you could save two percentage points on the loan. That's so you can get your closing costs back if you need to sell a year or more later, assuming your home doesn't go down in value.
But you can refinance by getting as little as 1/2 percent lower than your current mortgage interest rate and still be able to sell within a reasonable time - three years or so. What you need to do is figure how long it will take you to pay back your closing costs before you sell your home.
You have a $200,000 mortgage, 30 yr. fixed rate, 6% interest, with a monthly payment of $1199 in principal and interest or PITI. Assuming $2,000 in closing costs, you refinance for another 30 years.
At 2 points lower, or 4% interest, your new PITI (principal and interest) is $ 954.83 With a monthly savings of $244.17, it would take you just over 8 months to pay back the cost of the refinance.
At 1/2 % of a point lower, or 5.5% interest, your PITI is $ 1135.58. With a monthly savings of about $64, it would take you a little over 31 months to break even, a good strategy if you plan to stay in your home at least 3 years.
4. What type of loan do you currently have? Do you have a hybrid adjustable rate mortgage that needs refinancing?
Many hybrid loans roll from fixed rates to adjustable become adjustable after one year, three years, or five years. If you qualified for the adjustable rate loan originally, but have since increased your income or paid down your mortgage and built some equity, now may well be the time to refinance.
Interest rates have hovered near the five-point mark or lower for well over six years, making it likely that adjustable rates have nowhere to go but up, so it may be a good time to get into a fixed rate.
5. Have your plans or circumstances changed from when you first purchased?
Perhaps you're doing well and want to accelerate your pay-off by refinancing to a 15-year term. Additional payments to principal can be voluntarily added to your 30-year fixed rate loan payment, so refinancing is only wise if you can get a much lower interest rate than your current term.
Conversely, perhaps your intentions of paying off a 15-year note have changed, due to decreased income, family obligations or some other reason. In that case, a refinance to a 30-year term will ease your payments, but the majority of your note will be to pay interest, with little going toward your principal for several years.
Ask your mortgage banker or broker and your financial advisor or tax preparer to help you decide if refinancing is the right answer for you now.