Why 2015 Offers a Good Chance to Refinance a Mortgage
Want to save money on your mortgage payments? Now could be a great time to refinance, with interest rates near historic lows: Average 30-year fixed-rate mortgages dipped to 3.66% at the end of January, according to Freddie Mac. That’s far lower than the long-term average of 8.46%.
Refinancing can make mortgage payments more affordable, free up cash to pay off other debts, and improve your overall financial situation. But refinancing doesn’t make sense for every homeowner, and there are a few important factors to consider.
Mortgage refinancing explained
When you refinance, you take out a new mortgage and use the money to pay off the old one in full, usually leaving you with a lower-rate loan on your home. But it’s important to understand that refinancing doesn’t eliminate your home debt: You’re simply replacing one mortgage with another.
Not everyone qualifies. Homeowners looking to refinance generally should have at least 10% to 20% equity in the property and a credit score of 740 or better, according to Consumer Reports. Having less equity makes it tougher to win approval, and even if you are approved, the financial institution may charge a higher interest rate and add costly private mortgage insurance, which protects the lender if you stop making payments on the loan.
When to refinance
The main advantage of refinancing is saving money. A lower interest rate could significantly shrink your monthly payments, potentially saving thousands of dollars a year.
It may also make sense to replace an adjustable-rate mortgage into one with a fixed rate, to eliminate the risk that the rate may rise. By refinancing into a fixed-rate mortgage, you’ll lock in the new rate for the length of the mortgage. This way, you’ll know exactly what the monthly payment will be, even in 20 years. With an adjustable-rate mortgage, what you must pay can go up or down with the market.
If you have sufficient equity in your home, a “cash-out” refinancing can give you access to money to make a large purchase or pay for a remodeling project that increases the value of your home. It can also be used to reduce high-interest debt, such as credit card or student loan balances, at a lower rate. With a cash-out refinance, you borrow more than you owe on the old mortgage and take the difference in cash. Just remember that this cash isn’t free: You’re borrowing it, and you’ll have to pay it back. The interest you pay on a mortgage may also be tax deductible.
When not to refinance
Refinancing at a lower rate doesn’t always lead to savings. Closing costs and fees typically add up to 1% to 2% of the loan balance, according to U.S. News & World Report. That means refinancing a $200,000 loan could cost $2,000 to $4,000. Lenders like Metro Community Federal Credit Union can help you determine whether it’s a good time to refinance.
For those who plan on selling within the next few years, it may not make sense, as the fees and costs involved in refinancing will likely outweigh the savings on interest over such a short period. It can be a better idea for those who plan on living in their home for the long term, as they’ll have plenty of time to reap the benefits of interest savings.
It’s also important to figure out whether your current mortgage has a prepayment penalty. Check with your lender or review the mortgage contract to be sure, because these fees can potentially outweigh the savings.
Refinancing a mortgage can be a wise move with interest rates near historic lows. But whether it makes sense to take that step ultimately depends on your personal situation and whether you’re getting a good deal on the new loan.
Steve Nicastro, NerdWallet