People often opt for mortgage refinancing to reduce monthly payments, expedite loan repayment, or access home equity. Typically, homeowners consider refinancing during periods of declining or steady interest rates. The decision to refinance or not is a personal one and should be made after carefully assessing the pros and cons, considering your present financial situation and long-term goals.
This blog is to help you understand when the right moment for mortgage refinancing is and when exploring alternative options might be more advisable.
How Does Mortgage Refinancing Work?
Refinancing a mortgage involves obtaining a new mortgage to settle your existing one. It is similar to the process of securing a mortgage for a home purchase. Unlike the stress associated with home buying and moving, refinancing offers a more relaxed timeline, with less urgency to meet a specific closing date. Additionally, there’s a three-business-day window after loan closure to reconsider and cancel the transaction if needed.
During periods of widespread interest in refinancing due to lower rates, lenders may experience increased demand, potentially extending the refinancing process. It’s worth noting that refinancing a loan that is supported by the FHA or the Department of Veterans Affairs may take up to a week longer compared to a conventional refinance.
Reasons To Refinance Your Mortgage
There are multiple reasons to consider refinancing your mortgage:
- Lowering Interest Rates: Refinancing becomes advantageous when you can secure a reduced interest rate, typically by one-half to three-quarters of a percentage point. It is particularly beneficial if you plan to stay in your home long enough to recover the closing costs associated with the refinance.
- Better Credit Score: If your credit score has improved since you initially obtained your mortgage, you may qualify for a better interest rate. Keep in mind that the best rates usually go to those with a credit score of at least 740.
- Consolidating High-Interest Debt: A cash-out refinance allows you to tap into your home’s equity to pay off high-interest debts. This move can potentially save you a significant amount of money.
- Eliminating Mortgage Insurance: If the value of your home has increased, refinancing provides an opportunity to eliminate private mortgage insurance on conventional loans or mortgage insurance premiums on FHA loans. This is applicable once you reach 20 percent equity, and for FHA loans, MIP may be removed after 11 years with a down payment of at least 10 percent.
- Long-Term Stay: Refinancing makes sense if you qualify for more favorable loan terms and plan to stay in your existing residence for an extended period, allowing you to benefit from the cost savings. However, it may not be advisable if you anticipate moving soon, as the time frame might be insufficient to recover the new loan’s associated costs.
- Adjusting Loan Term: If you’re facing challenges with your monthly mortgage payments, refinancing with a longer loan term can result in a smaller monthly payment. However, it’s essential to acknowledge that extending the loan term increases the overall cost, as you’ll be paying interest for a more extended period.
When Not to Refinance?
Refinancing may not be the best choice in the following situations:
- Saving for a New Home: If you plan to move in a few years, the costs of refinancing (which range from 2% to 5% of the loan principal) may outweigh the benefits, taking a while to break even.
- Luxury Purchases: Using home equity for luxury items is similar to utilizing a credit card or personal loan. Despite a lower interest rate, both options can be expensive over time, and failing to make mortgage payments could lead to losing your home.
- Moving to a Longer-Term Loan: If you’re more than halfway through your current loan term, refinancing might not be wise. Restarting the loan clock means paying more toward interest again, undoing the progress of paying down the principal.
- Paying Off Your Home Loan Faster at the Expense of Other Goals: If you haven’t achieved other financial goals, like reducing high-interest debt, investing, saving for retirement, or funding a college education, using funds to pay off your home faster might not be the best use of resources.
- High Closing Costs: Take into account all the closing costs, such as application fees, underwriting fees, and processing fees. Only think about refinancing your loan if, after subtracting these expenses, you find yourself in a financially advantageous position.
- Recent Home Purchase: Refinancing within a year is generally not recommended. In such cases, the lender often benefits more than the borrower.
Conclusion
The decision to refinance depends on various factors, and careful consideration is crucial. Refinancing can be a good financial move if it aligns with your goals, such as lowering monthly payments, reducing long-term interest costs, or eliminating mortgage insurance.
It’s essential to be mindful of the associated closing costs and calculate the break-even point to ensure that the savings from a new interest rate outweigh the expenses of refinancing. Additionally, the timing of refinancing matters as to when it makes sense, as well as when it might not be advisable.
For personalized advice and assistance with your mortgage refinancing decision, feel free to reach out to Bond Street.
