IS IT WORTH REFINANCING MY MORTGAGE? (+ REFINANCE CALCULATOR)
August 16, 2022
Many people refinance their mortgages to obtain lower interest rates, to shorten their loan terms, or for other reasons. Before you refinance, however, it’s important to understand how the process works and to be aware of the fees involved. This will help you decide whether refinancing is worth it.
HOW DOES A MORTGAGE REFINANCE WORK?
A mortgage refinance is when you obtain a new mortgage to replace your current one. The new mortgage can be with either your current lender or with a different one.
When you apply for a new mortgage, the process will be similar to your first mortgage. Your lender will carefully evaluate your financial information to make sure you can pay back the money you borrow. Your employment and income will be verified, your credit will be checked, and your current debts will also be reviewed to make sure you aren’t overextended.
Your home will also be appraised to determine its current market value. Although real estate typically increases in value over time, there are some situations where your home may go down in value, like when a major employer in your community closes its operations. If your home has decreased in value, you might not qualify to refinance it.
WHEN SHOULD YOU REFINANCE YOUR MORTGAGE?
Before applying, it’s important to carefully consider the reasons you’d refinance your mortgage and whether or not doing so will help you achieve your goals.
The following are several common reasons why people refinance their mortgages:
To Lower Monthly Payments
A mortgage refinance can be used to lower your monthly payments by extending the loan term. The longer you have to repay your mortgage, the less your monthly payments will be. This can be helpful when money is tight.
An important negative of this strategy, however, is that while your monthly payments will decrease, you’ll end up paying more in interest over time because you will have refinanced with a longer loan term.
To Lock in a Lower Interest Rate
One of the most common reasons why people refinance their mortgages is to lock in a better interest rate, especially at times when rates are dropping. The savings can be substantial. A 1-2 point interest rate decrease could save you tens of thousands in interest over the life of your loan.
To Switch to a Fixed Rate
Many people choose variable-rate mortgages because the initial interest rate is often lower than fixed-rate loans. These introductory rates may last anywhere from 1-5 years. After that, the interest rate will vary depending on current market conditions.
The lower initial payments may allow some to afford a bigger home than they otherwise could. Some people may also go with a variable-rate loan when they know they won’t be living in their home for very long.
It’s important to consider things don’t always go as planned. Maybe the job you thought was going to be temporary becomes a long-term assignment. Or, when the interest rate begins to vary, rates may increase more than you expected.
Switching from a variable-rate mortgage to one with a fixed rate allows you to lock in the current rate to protect you from future rate increases. It ensures there will be no surprises, which helps with budgeting.
To Shorten Your Loan Term
Many people refinance to a shorter loan term so they can pay off their mortgages more quickly and thereby save money on interest. Consider the following example to see how big the savings can be.
If you have a $300,000 loan for 30 years with a 5% interest rate, you will pay just over $279,000 in interest over the life of the loan. With the same loan amount financed for 15 years, however, you will pay just over $127,000 in interest. This saves you approximately $152,000.
To Take Cash Out
Many people refinance their homes with a cash-out refinance loan to borrow the extra money they need for a home remodeling project or something else. With a cash-out refinance, you obtain a new mortgage for your home, but you borrow more than the payoff amount.
A cash-out refinance loan is a type of home equity loan where the extra money you borrow is backed by the equity you have in your home. Many lenders will allow you to borrow up to 85% of your home equity, so shop around before you take out your loan.
BE SURE TO CONSIDER THE CLOSING COSTS
Before you apply to refinance your mortgage, it’s important to understand you’ll have to pay closing costs for your new loan. Mortgage closing costs will vary depending on the lender, but are typically between 2% and 5% of the loan amount.
This could be a significant expense. If you are refinancing a $300,000 loan, for example, the closing costs will be between $6,000 and $15,000.
HOW TO DETERMINE A MORTGAGE PAYBACK PERIOD
One of the most important things to consider with a mortgage refinance is your new payback period. This is the length of time it takes to regain your financing costs.
To determine your payback period, you’ll need to know the approximate amount of the closing costs. Your lender can provide you with an estimate. You can then determine your savings by comparing your new monthly payment to your old monthly payment. You can estimate your new monthly payment using a refinance calculator.
Once you know how much you’ll be saving each month, you can plug the information into the following formula to determine the payback period.
Payback Period = Closing Costs / Monthly Savings
This will give you the number of months it will take to recover the closing costs for your new mortgage. It will help you determine whether refinancing is worth it, or if you would be better off keeping your existing loan.
REFINANCING WITH FIBRE FEDERAL CREDIT UNION
If you’re thinking about refinancing your mortgage, Fibre Federal Credit Union offers home loans with competitive rates and low fees. Click on the following link to see our low mortgage rates.