With interest rates still near historical lows, it may be tempting to refinance to a lower rate. Here are five questions you should ask yourself before you take out a new loan.
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 years or more after refinancing, it might not make sense to refinance.
2. What are the closing or settlement costs for refinancing?
Expect to pay about the same amount as when you purchased. Expenses will include a new title policy (if applicable), new appraisal, and lender's fees.
Typically, the lender will charge an origination fee or a "discount fee". If it's a "no-cost" refinance, the fee will actually be rolled into a higher interest rate.
3. What percentage rate are you currently paying?
Mortgage lenders once advised refinancing only if you could save two percentage points on the loan, but today they look at how long it takes to pay back the cost of refinancing your home.
Ask your lender to compare the savings in your monthly payment at the new rate. Take the monthly savings amount and divide it into your total closing costs. That will give you the number of months it will take to pay back your closing costs.
If it takes longer to pay back the closing costs than you intend to stay in your home, don't refinance.
4. What type of loan do you currently have?
One good reason to refinance is to get into a fixed-rate loan from an adjustable rate or other type of loan. Adjustable rate mortgages roll over from a fixed rate to an adjustable after one year, three years, or five years.
With interest rates expected to rise in 2014, it's a good time to get into a new loan.
5. Have your plans or circumstances changed from when you first purchased your home?
Perhaps you're doing well and want to accelerate your pay-off by refinancing to a 15-year term. If you already have a fixed rate, run the numbers to see how quickly you can pay off your loan by making extra payments.
You may find that the savings from paying down your principal far outweigh the advantages of refinancing.
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