Thinking About Refinancing Your Home? 6 Reasons Why You Should
What would you do with an extra $4,000 a year?
That’s a vacation in Hawaii, new hardwood floors, or even a down-payment on that Prius you’ve been eyeing. Best of all, you won’t have to put in more hours at the office to make it happen; all it takes is strategically refinancing your mortgage to take advantage of optimal interest rates.
It might sound crazy, but over two million people in the United States have shaved close to$8 billion off their annual mortgage payments through refinancing, and millions more are qualify to do the same. These homeowners are paying off their mortgages faster while holding on to more of their money each month.
You can too, if the math shows that home refinancing makes sense for you.
Understanding the Basics of Home Refinancing
In a nutshell, refinancing your home means paying off the existing mortgage so that you can qualify for a new one with a lower interest rate. This helps you reduce your monthly payments, shorten (or lengthen) your mortgage term or even switch mortgage companies.
Refinancing makes the most financial sense when you’ve built some equity in your home because you can leverage it against the value of your loan. However, there’s a catch. Refinancing home loans typically costs between 3 percent and 6 percent of the loan’s principle, which usually takes years to recoup through the money you save paying a lower interest rate.
For this reason, refinancing makes the most sense if you plan to stay in your home long enough to realize the benefit from these savings.
6 Reasons to Refinance Your Home
Saving money is just one reason to refinance your home. Below are six reasons why switching out your mortgage may be one of the best financial decisions that you will make this year.
The Housing Crash Knocked out Your Savings
A decade ago, the housing crisis in the United States caused millions to lose the equity they had built up in their homes. This led to years of poor real estate resale rates, and many lost a chunk of their savings because of it.
If your bank account plummeted after an ill-timed home purchase, you might currently be locked into an interest rate that’s costing you thousands every year. Refinancing the loan can get your rate back on track and let you put more money towards building equity instead.
Interest Rates Will Go up Soon
After the 2008 housing crisis, the federal government dropped interest rates to historic lows to keep as many Americans in their homes as possible. Now, 10 years later, interest rates are on track to rise back to pre-crash levels. This means that your window of opportunity to qualify for reduced rates is quickly closing.
By tapping into lower rates now, you can pay off your principal faster, leaving you with less debt in the long run. Even a few percentage points of change to your interest rate means the difference between spending or pocketing thousands of dollars over the course of your mortgage.
Are interest rates low enough for refinancing to be a good move for you? Historically, the rule was that refinancing was financially worthwhile if you could decrease your interest rate by 2 percent or more. Today, though, many lenders are recommending refinancing for savings of 1 percent or even 0.5 percent, meaning that locking in a lower rate might make sense for you.
Your Credit Score Has Improved
If you’re a first-time homebuyer, you might hold debt on your car or student loans, and even a few past due payments on these accounts can decimate your credit score.
Your score is likely to recover after years of balancing your budget, at which point you may qualify you for a better interest rate. For instance,BankRate notes that your credit score can affect your interest rate by as much as 1.5 percent, which comes down to hundreds of dollars every month.
A score of 760 or higher tends to qualify you for the best interest rates, so refinancing might make sense if your score is in that sweet spot.
Refinance with Confidence
Get this 7-Step Guide to prepare.
You’re Preparing for a Major Financial Change
Life rarely follows the preconceived plans that we have for it, meaning that financial curveballs may demolish your savings at some point. Whether you’re saving for a new car, planning a dream vacation or finally finishing college, taking out a personal loan can trap you with sky-high interest rates that will take years to pay off.
Refinancing your mortgage instead can keep your interest rate under control and give you more liquid capital to handle unexpected large purchases. If you’ve paid off a sizable portion of your home, you can also tap into its equity to cover home expenses like a remodel. Often it’s worth the fees for refinancing because the upgrade will add to the resale value of your home.
You’re Making More (or Less) Money Than Before
Your annual income is one of the biggest factors deciding the mortgage interest rate you qualify for, but in today’s world, careers are anything but static. In all likelihood, you aren’t earning anything near what your salary was when you initially qualified for your mortgage, and a refinanced interest rate will better reflect where you are now.
Refinancing your home mortgage lets you get the interest rate that makes the most sense for you today, allowing you to save significantly more money in the long run. For example, a boost in financial resources can qualify you to trim down your interest rate and pay off your home years ahead of schedule, leading to thousands (even hundreds of thousands!) in savings.
In the same way, refinancing your 30-year mortgage to maximize your monthly income can leave you with smaller payments and more expendable capital for your needs.
Your Other Debts Are a Bigger Priority
For most homeowners, your mortgage is just one of many debts you juggle every month, and it’s usually the cheapest. While home-loan interest rates tend to stay under 5 percent, other debts can quickly reach 16 percent or higher.
A smart financial strategy usually involves prioritizing these debts so you pay off the highest interest rates first and keep your money in your possession for building home equity. To target these higher rates, you can refinance your mortgage with a home equity loan or even a cash-out option. This leaves you with a lower rate, smaller monthly payments and more expendable money to throw at your most frightening loans to get them under control.
At face value, focusing on high-interest debt instead of a low-interest mortgage makes sense. However, bad financial habits are harder to change and can get you back into trouble if you aren’t careful. Once you pay down your debts, it’s critical that you keep putting money towards your mortgage. Otherwise, you could lose equity on your house, fail to recoup your refinancing fees and even slog through extra years of interest payments.
Risk Factors to Consider Before Refinancing Your Home
At first glance, mortgage refinancing looks like free money. However, it’s not the right strategy for everyone and can lead to unexpected costs if you aren’t careful about what you sign up for.
Refinancing is a smart financial move if it reduces your mortgage payment, shortens the life of your loan or helps you build equity faster. Unfortunately, some people find it to be a slippery slope that leads to lifelong debt instead. The difference comes from knowing exactly how much refinancing will save you and what use you plan to put your money towards instead.
You should expect to pay refinancing costs of 3 percent to 6 percent of your new loan, which can take years to recoup. Moving out of your home earlier than expected, or not considering tax incentives, can make refinancing a bad financial move, so do your homework before committing so you make the best choice you can.
How to Decide if Refinancing Is Right for You
Refinancing your home loan may save you money every month, but it’s not the right financial strategy for everyone. To decide if you should pursue refinancing, you need to evaluate how the costs will compare to the savings on a month-to-month basis.
Mortgage experts generally recommend you pursue refinancing if the savings fall within the range of 0.5 percent to 2 percent. To get a better idea, you can do the math.
Calculating the Benefits of Refinancing Your Mortgage
First, determine how much interest you’ll save monthly, accounting for the fact that you’ll save less as you pay off the principle.
Make sure you take your tax rate into consideration, as mortgage interest is tax deductible. If you itemize your tax deductions, you need to reduce your interest savings by your marginal tax rate so that the smaller deduction is accounted for.
Second, calculate the overall cost (or have your mortgage broker do it for you!) of refinancing your mortgage.
Finally, divide the total cost by your monthly post-tax savings to determine if refinancing is worthwhile. The result is the number of months it will take you to break even.
Refinancing makes sense if you plan to live in your home after that point. If not, your current rate is the better financial choice for now.
Refinancing your home is a smart financial decision that millions of Americans should tap into before mortgage rates rise back to pre-recession levels. If you think that mortgage financing makes sense for your situation, you should talk over the details with your mortgage broker and take the steps to lock in a lower rate before the opportunity passes you by.