Mortgage refinancing is a hot topic in the homeowner world. With interest rates being some of the lowest we’ve seen in years, should you refinance? How do you know if you should refinance? A mortgage is probably one of the biggest, if not THE biggest, loan you will ever take – make sure you know how to make the most of it!
What is refinancing a mortgage?
Let’s start off with what it means to refinance a mortgage. Refinancing a mortgage means paying off an old loan with a new loan. When you refinance your mortgage, you’re basically revising the original mortgage, not starting completely from scratch.
How does refinancing a mortgage work?
Refinancing a mortgage starts just like any other loan – you have to find out if you qualify and gather your information together to show your financial institution that you’ll be a good lender. There are a few specific qualifications you have to meet to refinance a mortgage:
- You’ve maintained and paid for your original mortgage for at least 12 months
- You have 10-20% equity in your home
- You have a regular income and a good debt-to-income ratio
- You have a good credit score
Once you’re approved, you’ll take out a new loan that will cover the amount you still owe on your original mortgage – or more, depending on the type of mortgage refinancing you’re doing. You will then use the new loan to pay off the original mortgage. After that, you only make payments on the new mortgage.
When should you refinance your mortgage?
There are a few different reasons why you might want to consider refinancing your mortgage, all with the end result of having greater financial independence.
Shorten the term of your mortgage
If the length of your mortgage is over 15 years, refinancing is a great way to hit the goal of having a 15-year mortgage. Ideally, refinancing from a longer term mortgage to a 15-year mortgage would give you a payment that is no more than 25% of your take home pay, in addition to drastically lowering the amount of interest you will pay throughout the life of the mortgage.
If you’re looking at refinancing to lower your mortgage length, you also have to look at the interest rates on your current mortgage compared to the mortgage you could refinance into. If the interest rate on your 25- or 30-year mortgage is low enough that it rivals the rates of 15 year mortgages now, you may be better off making extra payments on your current mortgage instead of refinancing.
Secure a lower interest rate on your mortgage
If you have a high-interest rate mortgage compared to the current market rates, refinancing could be a smart move towards financial independence. Generally, if you can find a loan that has a 1-2% lower interest rate than your current mortgage, you should consider it. You should still do a break-even analysis and think about how long you plan to stay in this home before you make the move.
Refinance out of an ARM
ARM’s, or Adjustable Rate Mortgages, seem great in the beginning when you are promised a low interest rate to begin your journey as a homeowner. After that initial period of time, however, your interest rate will adjust based on the mortgage market, the LIBOR market index, and many other factors. When the markets fluctuate, an ARM can end up costing you a lot more money than you originally planned. If you have an ARM and are planning on staying in your home for a long time, refinancing to a fixed-rate-mortgage could be a great financial move.
Refinance to consolidate debt
The low interest rates of today’s mortgage loans also makes them a financially savvy way to consolidate debt. This would be done in what is called a “cash-out” mortgage, in which you borrow more than you owe on your home. If you choose to use a mortgage to pay off credit card debt, keep in mind that if you continue to rack up credit card debt and start missing mortgage payments, you could lose your home.
How to know if refinancing is worth it
The burning question still in your mind is probably – “is refinancing my mortgage really worth it?” When you refinance a mortgage, you still have to go through the home inspection, the paperwork, and the closing costs, so how do you know if you are making a smart financial move?
Calculate your break-even point for a mortgage refinance
The best way to know if you’re making a good choice by refinancing your mortgage is to complete a break-even analysis. You do this by dividing the total closing costs by the amount you save each month with your new payment. For example, say your new mortgage payment saves you $200 a month and closing costs were $2,500. $2,500/$200 in savings = 12.5 months until you break even. As long as you plan on staying in your house longer than it will take you to break even, refinancing is a good financial move.
Ready to refinance your mortgage?
If you still have questions about whether or not a mortgage refinance is the best financial option for you, our friendly and knowledgeable mortgage consultants are more than happy to help! If you’re ready to refinance and improve your mortgage, we can help with that, too! Contact our mortgage department by calling 717-709-2580, or visit any of our branches to set up an appointment with a mortgage consultant.