When is a good time to refinance?
There are various considerations when evaluating a possible refinance, the most obvious one being to get a lower rate. Yet, while a lower rate can motivate someone to refinance a mortgage, there are questions that need to be asked - and answered. And, there is an easy way to find out if a refinance is worthwhile.
How much lower does the rate need to be?
When you hear that interest rates have fallen, how much lower should the rate be before jumping into the refinancing waters? The answer is not in the interest rate but how much lower your new mortgage payment will be; with an eye on the closing costs required when obtaining any new loan.
That means there is no general "rule of thumb" that says it's time to refinance your current loan if rates fall more than one percent lower than your current rate. Or two percent, for that matter. In fact, sometimes it's a good idea to refinance your current loan even when your payment goes up, not down, but we'll discuss that tidbit shortly.
To find out if it's worthwhile to refinance, subtract the difference between your current principal and interest payment and your new one. For example, your current mortgage is a $200,000 loan with a 30 year fixed rate at 4.50 percent. That gives you a $1,013 monthly principal and interest payment. Compare that payment with available interest rates and we'll say that rates today are 3.25 percent. The new monthly payment is $870 on a $200,000 30 year mortgage.
The monthly savings is $143 per month. Now divide the savings into the closing costs required for a new loan. If closing costs add up to $4,000, divide that amount by $143 and the result is 28 (months). As long as you keep the mortgage long enough to recover your closing costs, then a refinance might be in your future. Pay less attention to the how low the rates drop and more attention to how long it takes to recover your closing costs.
Lenders can also offer "no closing cost" loans where your interest rate is adjusted and there are no closing costs at all. This feature is based upon current rates and the loan amount among other factors but should always be an option. The rates for a no closing cost loan won't be as low as other rates, but you get to lower your monthly payment without any fees.
Another reason to refinance is to adjust the term. The longer the mortgage term of any mortgage, the lower the monthly payment but there's a caveat; you'll pay much more in interest to the lender. For example, with that same $200,000 30 year mortgage at 3.25 percent, the amount of interest paid to the lender over the life of the loan is $164,680.
Now take a similar 15 year loan with a rate of 2.50 percent. The rate is lower but because the term is shortened, the monthly payment actually increases to $1,333, more than $320 higher than your existing payment.
But that's not the benefit with a 15 year loan. The benefit is the amount of interest saved. Over the life of the loan, only $39,940 of interest, or nearly $125,000 less is paid to our lender compared to the 30 year mortgage.
Another refinancing option takes equity out of a property in the form of cash. During the refinance process, you can elect to borrow more than your existing loan and closing costs. Say that your current loan is $200,000 and closing costs are $4,000. You can pay the closing costs out of your pocket but most borrowers roll closing costs into the loan amount.
A cash out refinance might be $224,000, paying off the existing $200,000 loan, $4,000 in closing costs and putting $20,000 cash in the pocket of the borrower. Additional restrictions apply to cash out loans, so make sure you talk to a loan officer and understand the guidelines.
Taking out cash should be a secondary priority when thinking about refinancing your loan due to the closing costs involved. If you only want to tap into your equity for extra funds, consider an equity loan from your bank instead.
This information was provided by Tactile Finance Pro, a trusted subcription service of mine. If you are trying to determine if refinancing makes sense for you, contact me for a free, no-obligation analysis and review. My team and I lend in MD, VA, DE, NC, SC, GA, FL, TN and TX and can meet you via an interactive online session or in person. Often times, an appraisal is not required for certain types of refinances.
Loan approval is subject to individual program guidelines. Gateway Bank Mortgage does not guarantee approval of any applicant until after their file has been reviewed by an underwriter. Loan amount is subject to property appraisal and individual program guidelines. Loan rates and terms are subject to change based on market at time of rate lock.