If you’re wondering whether to refinance your home loan, you’re not alone. It’s hard to know exactly when to refinance.
Factors to consider before refinancing
Before refinancing your mortgage, there are seven factors you should consider.
1. Interest rates
A general guideline for deciding whether to refinance is to find out if you can get your interest rate lowered by at least 2 points. This two-point figure is generally accepted as the safe margin when determining if the cost of refinancing a mortgage is worth the potential savings. However, other experts believe that mortgage refinancing is worthwhile even if you’re only able to secure a 1 ½ point decrease, if you plan to remain in your home for at least three years.
2. Length of time you plan to stay in your home
To find out how long it will take to recover refinancing fees, divide the total cost of refinancing by the amount you’ll save on your mortgage payment each month. The resulting number is the length of time, in months, that it will take to break even. If you plan to stay in your current home longer than this amount of time, refinancing may be a good idea.
3. Your loan type
Saving money is only one of the benefits of refinancing your mortgage loan. Another reason many people refinance is to switch the type of loan they have. Some customers start out with an adjustable-rate mortgage (ARM) loan to take advantage of the low initial rate, then refinance into a fixed rate product before the rate increases at the end of the adjustment period.
4. Your home equity
Another reason many homeowners choose to refinance is to build equity faster, or to leverage the equity they already have. When you refinance a 30-year loan to a 15-year loan, you’ll build equity twice as fast. This refinance strategy will also help you save money in interest because it will only take you half the time to pay off your loan.
On the other hand, if you’ve already built some equity in your home, you can tap into it to help fund education, home improvements or other unexpected expenses. With this strategy, you may refinance your mortgage loan for more than you currently owe to get access to the cash you need.
5. Your credit score
When you applied for your current mortgage, your rate was determined in part by your credit score at the time. If your score has improved significantly since taking out the loan, it may be a good time to refinance your home. The criteria that determine the credit-score-to-loan-rate relationship may change over time as well, meaning that a credit score that used to be considered average may now be considered above average. Requesting annual credit reports can help you monitor your credit score and help you decide when to refinance your home.
If your loan balance is less than 80% of your home’s value, private mortgage insurance (PMI) is usually not required. Eliminating PMI doesn’t always require refinancing, but refinancing your home can remove this unnecessary expense while restructuring your loan for a lower rate or different term length.
7. Your loan terms
If your goal is to build equity in your home quickly and you’re less concerned with lowering your monthly payment, you may want to refinance to a shorter-term mortgage. You’ll probably pay more per month, but a shorter loan term means that you’ll own your home sooner and pay less in interest over the course of the loan. As an added bonus, you can access that extra equity later for an emergency or a large purchase through a home equity line of credit (HELOC) or home equity loan (HEL).
Knowing when to refinance a mortgage loan can be tricky, so speak with a financial advisor before making such an important decision. Also use a mortgage refinance calculator to get an idea of what your refinance home loan rate and monthly payments might be.