A mortgage is a big deal. Not only is it a big sign that tells the world that you’re a homeowner, but it’s also a big financial responsibility. Every month you have to pay a certain amount to keep your home, pay off what you borrowed, and reduce the amount of interest you owe for borrowing that money in the first place.
If you’ve ever wished your mortgage payments were lower, or that you had a little more money to do repairs or go on vacation (and really, who hasn’t?), then you’ve probably considered refinancing your mortgage. But is it the right choice for you?
Let’s break it down.
First, what does it mean to refinance a mortgage?
To put it simply, refinancing a mortgage is basically getting a new mortgage to replace your current one, but at a better interest rate and term length. When you go to a mortgage lender to refinance, that lender will pay off your current loan and create a new one for the remaining balance, or more, if you decide to use some of the funds for other reasons, but we’ll get to that later.
Why should I refinance my mortgage?
We’ve already touched on two reasons for refinancing: a better interest rate and a better term length. Both of these will lead to the third reason: lower monthly payments. Interest rates fluctuate all the time, and when they’re low, they can get really low, which means you would have to pay less on your mortgage. Refinancing your mortgage during a drop in interest rate could mean a significant saving of money over the life of your loan.
And if you adjust your term rate, you could also drop your monthly payments. If you originally took out the standard 30 year loan, and have been paying it off for the last 10 years, but refinance the rest at another 30 years, your monthly payments will drop by a fair amount. You’ll still be paying the same amount in the long run, but stretched out over a longer period of time with smaller payments.
Another reason to refinance is if you are looking to make improvements on your home, or could use some extra cash for something else. By refinancing, you can change the amount of the loan (though you can only increase it and not decrease it, sadly) to give you those extra funds at a potentially better rate and term than taking out a personal loan.
Also, if you took out an FHA loan, or something similar that allows you to put down a smaller down payment, and have to pay mortgage insurance (PMI) with your mortgage payment, refinancing could help remove that. Mortgage insurance is put in place when home buyers purchase a home without putting down the traditional 20% down payment as protection for the mortgage lender should you default on the loan. But you only need to have PMI on your mortgage until the loan-to-value ratio is 78% (or when you’ve paid a little more than the equivalent of that 20% down payment). If you’ve reached that point and want the PMI removed, consider refinancing to a conventional loan.
Why shouldn’t I refinance?
While refinancing can help you save a fair amount of money, there are a few cases where you shouldn’t consider refinancing. For example, take a look at your credit. Has it gone up or down since you first bought your home? If it’s gone up, great, refinancing might be a good idea for you. If it’s gone down, though, refinancing could mean a higher interest rate. Credit scores are one of the major components to determining your mortgage interest rates, so higher scores mean lower interest rates.
Refinancing also comes with a new set of costs. You’re opening a new loan, remember? And that means there are closing costs to pay when refinancing. They could range from 3% to 6% of the loan balance, depending on the lender and other factors. You’re essentially buying your house all over again, so you’ll need to pay for a home appraisal, applications, titles, and so on.
And because you need to have an appraisal again, that could damage your chances of refinancing. If you bought your home at the top of the market (like during the housing bubble back in 2007), you may have gotten a mortgage for more than what your house is currently worth. Appraisers look at comparable houses in your area to help determine the value of your home for the refinance. If the appraiser comes back and values the home at less than the current balance of the loan, your refinancing could stop in its tracks.
So how do I know if I should refinance?
The best way to know when to refinance (or if you should refinance) is to talk to a mortgage advisor you trust. Whether it’s the mortgage advisor who helped you with your first mortgage, or another you’ve met since then, have a conversation about the possibility of refinancing. They know the market, as well as your finances, and can help you get a better sense if refinancing will help or hinder you. For example, Dime Community Bank has mortgage consultants to help you understand the refinancing process and determine if it’s right for you.