If interest rates are low, refinancing your home mortgage loan can seem like an attractive option to get smaller payments or significant savings. If you’re thinking of refinancing your home, it’s important to have a good understanding of the the right timing, the costs and the available types of refinancing options to ensure you make the optimal move for your future.
What is refinancing?
Refinancing is when you choose to replace an existing loan with a new loan with new terms. In essence, you take the newly borrowed money to pay off the old loan and are in turn bound by the terms of the new loan. Refinancing is typically done for a few different reasons: to save money through a better interest rate, lower existing payments, secure a loan with more favorable terms or better align your loan with your future financial goals.
Types of mortgage refinancing
When it comes to refinancing your mortgage, there are plenty of unique options for homeowners to choose from. The most popular options include rate and term refinance, cash refinances and short refinances. Each of these different options can be customized much further based on your specific needs.
Rate and term refinances are the most popular option and are used to get better rates or different terms. These types of refinanced loans are ideal when something has changed in your financial picture or you are expecting something to change. For example, if your credit has improved or interest rates have dropped, you may be able to secure significant savings.
Another popular refinancing move is shifting from your existing loan into an adjustable-rate mortgage (ARM). ARM loans typically come with a lower interest rate for a fixed introductory period of time that then revert to the associated interest rate index. These loans are great for those planning on selling their home before the introductory period is over or who think interest rates may drop in the future.
Short refinances exist as lifelines for those who may be in a financial bind putting them at risk of losing their home. No one plans on life hitting them hard, but if it does, rest assured that there are refinancing options available to help you weather the storm.
When is the right time to refinance my mortgage?
The right time to execute will depend on the type of refinance you’re looking into. Life or market conditions will often dictate the opportune time. For short refinances, your personal financial situation will drive the decision. Those looking to change rates or terms will want to consider refinancing when their credit score improves or when rates are low.
Refinancing in a seller-favorable market could be the right move as opposed to selling.
“Currently, the housing market is considered to be more leveraged for a seller, nationally and in certain markets. This is a contrast from the post-2008 market collapse,” Richard Sailors, an industry expert with Keller Williams, said. “During that time, rates were still low. Sellers across the country had lost a tremendous amount of equity in their homes. In many instances, it made much more financial sense to refinance their home loans to a lower rate as opposed to selling.”
“Today, however, with sellers regaining with more leverage and equity they still need to take heed to the low rates. Many sellers upon selling their homes immediately become buyers and are subject to less leverage in purchasing,” Sellers said. “It makes a lot of sense for buyers to consider refinancing their home instead of selling because it could be significantly more costly to buy a house in a seller’s market.”
The cost of refinancing your mortgage
It’s easy to look at only the interest rates and market conditions when deciding whether or not to refinance your mortgage. The problem with this tactic is that there are costs associated with refinancing that need to be weighed before proceeding. For example, when you secure a new loan you will be paying closing costs again. While this may not be an immediate dealbreaker, it’s still important to weigh the costs against your potential interest savings to see if you’ll come out ahead.
It’s also important to avoid tunnel vision caused by lower payments, which could lead to paying more in interest over the long run. Refinancing at a lower rate may seem attractive but it does not erase any of the debt that you owe. Ensure you’re not tacking on extensive additional interest payments unless it’s absolutely necessary.
You’ll also want to compare the benefits and drawbacks of your current loan against the new loan. Take the time to read the fine print to ensure your refinanced loan is, in fact, a better deal for you. Remember, “better for you” does not just mean better for you right now. It means better for you in the future as well.
Interest rate trends
Interest rates in the U.S. have been steadily dropping over the last year, which can make the idea of refinancing your home more attractive. In February of 2019, 30-year-fixed mortgage rates were just over 4.5%, and in January 2020 rates were down to about 3.8%. These lower rates could mean significant savings on new and refinanced mortgage loans.
The bottom line
Refinancing your home loan can help you save money or secure more favorable terms, and as interest rates continue to drop, the appeal to homeowners continues to grow. If you’re interested in exploring refinancing options, consider all available options, calculate potential costs or savings and weigh the pros and cons of the change. Ultimately, you should do what’s best for you and your family in both the short and long term.