Laura Adams discusses the key factors to consider when deciding whether to refinance your mortgage, including the benefits and potential drawbacks. She offers practical tips to help homeowners determine if refinancing is the right financial move based on current interest rates, home equity, and long-term plans.
Laura Adams discusses the key factors to consider when deciding whether to refinance your mortgage, including the benefits and potential drawbacks. She offers practical tips to help homeowners determine if refinancing is the right financial move based on current interest rates, home equity, and long-term plans.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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If you're a homeowner, your mortgage payment is probably your largest monthly expense. So, it's wise to stay alert for opportunities to refinance your home loan for a lower interest rate and cut your payment. Plus, your financial circumstances and needs today may differ from when you originally got your mortgage.
In this post, I'll cover what a mortgage refinance is, common reasons for doing one, and tips to know when it's right for your situation.
Hey friends, welcome back! I'm Laura Adams, an award-winning author, money speaker, founder of The Money Stack newsletter, and host of the Money Girl podcast with 43 million downloads. I also work as an on-camera financial spokesperson and partner with select brands for PR and content marketing. As always, you can learn more and email me at LauraDAdams.com.
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What is a mortgage refinance?
Refinancing a mortgage is when you get a new mortgage that pays off and replaces your existing one. The new loan can be with your same institution or with a different lender.
Here are several types of refinancing options that homeowners can use to accomplish various financial goals.
Another reason to refinance is when you have a mortgage co-borrower, such as an ex-spouse, that you want to remove from a home loan instead of selling the property.
You might want to do a cash-in refinance when having a lower loan-to-value ratio qualifies you for a lower mortgage rate or allows you to get rid of private mortgage insurance (PMI) payments. I’ll talk more about that in a moment.
When is the right time for a mortgage refinance?
The right time for refinancing a mortgage depends on the terms of your current home loan, the interest rate environment, and how long you plan to own your property. If you bought a home over the past couple of years, your interest rate was probably higher than you wanted to pay.
Interest rates reached a 23-year peak of 7.79% for a 30-year fixed-rate mortgage in October 2023. That's actually tame compared to interest rates that skyrocketed to 18.63% in October 1981!
But when mortgage rates drop, mortgage refinance lenders give you a better deal to get your business. Compared to last year, refinance applications have increased 118%.
Here are five tips when doing a rate-and-term refinance may be right for you.
1. You have enough home equity.
When shopping for a mortgage refinance, an important issue that could make or break the deal is how much home equity you have. Equity is the difference between what your property is worth and how much you owe.
For instance, if your home is worth $400,000 and you owe $300,000, you have $100,000 or 25% equity ($100,000 / $400,000 = 0.25).
The best situation for a refinance is to have at least 20% equity. You can still find lenders to work with you if you have less. However, unless your credit is excellent, you'll typically pay a higher interest rate when you have low equity.
In addition, when you don't have at least 20% equity, you're on the hook for private mortgage insurance (PMI). Adding PMI to your new loan could cut your savings and give you a much longer break-even point, which I'll review more about in a moment.
If you're unsure how much home equity you have, don't let that stop you from inquiring about your options to refinance and save money. Housing prices have risen significantly since the pandemic in most parts of the country, so you could have more equity in your home than you think!
2. You can get a lower interest rate.
If you're paying at least 0.75% more than the going mortgage rate, which is about 6.49% as of late August 2024, you're in a great position to consider refinancing.
Suppose you have a $300,000 fixed-rate mortgage at 7.79% and can refinance to a 6.49% loan. That rate reduction could cut your monthly payment by about $260, saving nearly $95,000 in interest over 30 years.
But you must do your homework and understand what a refinance will cost. The total fees could range from 2% to 6% of the loan amount, depending on where you live and your lender.
Fees go to professionals who provide services for a refinance, such as the lender or mortgage broker, property appraiser, closing agent or attorney, surveyor, inspector, local recording office, and maybe others, depending on where you live. It's rare, but you could also have to pay a prepayment penalty to pay off your current mortgage early.
If you can't afford to pay refinancing closing costs upfront, you may be able to roll them into the new loan. But that increases the amount you borrow and may also increase your interest rate. Always ask potential lenders for a side-by-side comparison of the cost and terms for different loan options so you can carefully evaluate them.
I recommend shopping for a refinance with the lender who holds your current mortgage, plus one or two different companies. Let your mortgage company know that you're shopping for the best offer. They may be willing to waive specific fees if some of the required work, such as a title search, survey, or appraisal is still current for your home. Just be sure they don't raise your interest rate in exchange for cutting your upfront fees.
3. You plan to stay in your home for several years.
Once you know what a refinance will cost, ensure you'll own your home long enough to cover the expense; otherwise, you'll lose money on the deal. It generally takes at least three years to save enough money on a refinance to make it worthwhile.
However, you should do the math to know exactly how long it would take you to break even. The formula entails adding up your total closing costs and dividing them by your monthly savings as follows:
Refinance break-even point = Total closing costs / Monthly savings
For instance, if your closing costs would be $12,000 and you'd save $260 a month on your payment by refinancing, it would take you 46 months or just over 3.5 years to recoup the cost:
$12,000 total costs / $260 savings per month = 46 months = 3.8 years to break even.
If you stay in your home for at least that long, you'll pass the break-even point and come out ahead. Note that you can refinance your mortgage as often as you wish. But if you're not confident you'll own your home past the break-even point, refinancing doesn't make financial sense, and you should keep your current mortgage.
4. You have an adjustable-rate mortgage (ARM).
Buying a home with an adjustable-rate mortgage has advantages like a lower interest rate, lower monthly payments, and perhaps qualifying for a larger loan than getting a fixed-rate mortgage. With an ARM, when interest rates go down, you benefit because monthly payments get smaller.
But if interest rates rise, you can feel panicked as your ARM payments increase. While there are caps on annual ARM increases, your mortgage rate could double within a few years if interest rates have a significant spike.
Instead of worrying about how high your adjustable-rate payment could go, consider refinancing to a fixed-rate loan to lock in a reasonable rate that will never change. No matter what happens in the economy, you'll have a monthly payment that's the same. A stable mortgage payment can make it easier to manage your expenses and stick to a spending plan.
5. You have good credit and income.
Similar to when you got your original mortgage, a refinance lender will evaluate your:
ALSO READ: Know your score and improve your credit
What are the benefits of mortgage refinancing?
The primary benefit of refinancing your mortgage is saving money with lower monthly payments. That could add up to tens of thousands of dollars over the life of your loan.
You can also change a mortgage's term to shorten or lengthen it. For instance, if you have 28 years remaining on your mortgage, you can refinance to a 30-year or a 15-year loan. Choosing a significantly shorter repayment term will increase your monthly payments but it dramatically cuts the amount of interest you must pay.
A cash-out refinance allows you to access your home's equity for any purpose. However, you may get a better rate using a home equity line of credit or HELOC.
Refinancing also allows you to change the owner of a mortgage, such as changing it to one person in a couple after a split or divorce. It’s a common solution if one person wants to remain in a home or buys out a property’s co-owner.
What are the downsides of mortgage refinancing?
The biggest downside of refinancing is its cost. You must pay many closing costs, which may be less than getting your original mortgage but are still significant. As I mentioned, they could range from 2% to 6% of the loan amount.
If you refinance a mortgage for a significantly longer term, such as having ten years remaining, but extending the balance to a new 30-year loan, you could pay more over the life of the loan. The longer your mortgage term, the more interest you pay.
Another downside I mentioned is that some mortgages charge a prepayment penalty if you pay off the loan early. Most mortgages don't have this but check before committing to a refinance.
To sum up, if a mortgage refinance helps you save money, despite its costs, it's an excellent money move. But for most homeowners who already enjoy rates lower than today's, some below 3%, refinancing may only make sense if it's for a reason other than saving money.
However, if you bought a home within the past year or two when mortgage rates were higher, refinancing is a wise strategy to consider. If you need help crunching the numbers, speak with a mortgage professional who can help you understand the costs and your break-even point for staying in the property long enough to recoup them.
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That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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