Should I Refinance? A Complete Decision-Guide
Refinancing could be a great idea when interest rates have dropped. However, even when rates are low, it may not be in your best interest to refinance. It’s important to know when to refinance to take advantage of beneficial rates. If you would like determining what a refinance would mean for your monthly payment, term and total paid, one of our loan experts would love to help you out.
When to Refinance a Loan
Reducing your loan’s interest rate can save you money – the top reason for refinancing. A $100,000 mortgage loan at a 5% interest rate over 30 years that is refinanced to 4% drops the total paid amount from $193,000 to $171,000.
Monthly payments drop by $60, which is a significant amount for many homeowners.
Term length may be extended, so if you have 5 years left on your loan, you may extend your loan further, depending on the loan type. Extending the loan can lower monthly payments even more, but you’ll be paying more in the long-term.
A few things to consider when you refinance a loan are:
- If you’re trying to sell your home soon, refinancing doesn’t make sense because you’ll be paying closing costs that won’t be recuperated in a few months’ time.
- Interest rates. Current interest rates are low. Typically, it only makes sense when the interest rate is 0.5% to 1%+ less than your current loan rate.
- Large loans may benefit from even a 0.25% reduction in interest rates, but these are often substantial loans.
- Closing costs for the loan can impact savings if you plan on paying off the loan in the short-term or sell the home. Closing costs vary from one lender to the next and can range between 2% and 5% of the loan.
You will need to provide documentation, have a good credit history, be able to show income and qualify for the mortgage. A new underwriting process is required, so you’ll need to prove that you can still pay the loan. Since you’re refinancing a mortgage loan, the bank will want the home appraised to ensure it is worth more than the loan value.
Cash-out Mortgage Refinancing
When refinancing a mortgage loan, you can opt for a cash-out refinance. You’ll be borrowing money from the equity that you have in the home and can borrow more than you owe. The cash-out option is a good choice when you have other debts with high interest rates:
- Credit cards
- Personal loans
You can use the money for other major expenses, too.
Calculate the Cost of Closing
Every refinance will have some form of closing costs. You should calculate your break-even point to determine if the refinance is right for you. You can do this by calculating your savings and closing costs.
Divide your costs by your savings to calculate how many months it will take to break-even.
For example, let’s assume that you’ll save $150 a month and pay $2,500 in closing costs. Using this calculation, it will take 16.7 months to recuperate your closing costs.
If you plan on paying off the loan faster than this period or sell the home, refinancing may not be a good option for you.
Otherwise, if you can recuperate your closing costs and enjoy long-term savings from refinancing to a lower interest rate, it may be a good idea to refinance. You can always flip your savings back into the payment to pay off the loan quicker, or you can simply use the savings for other expenses.