When you refinance your mortgage, you’re simply replacing your current mortgage with a new one. Sounds simple enough — but the refinancing process can be every bit as challenging as when you first bought your home.
The main reasons homeowners refinance are usually to get a better interest rate — which can lower your monthly payments and save you thousands of dollars in interest over the course of a loan — or to switch from an adjustable-rate mortgage into a fixed-rate loan. While it’s true that refinancing might save you money in both the short and long term, refinancing your mortgage does take some time, money, and effort, and you need to run the numbers to make sure you’ll actually realize the savings so many lenders promise.
There’s a bit more to refinancing than simply locking in a lower interest rate on your mortgage. Just like when you first bought your home, you’ll owe closing costs and other fees, such as a bank appraisal — so it’s important to factor in these additional costs to understand if refinancing is really worth it.
However, to get a ballpark idea of how much you could save, below is a current rate table with today’s best mortgage rates. Use this tool to compare your existing rate with current market rates. Generally speaking, if you can shave off a full percentage point of interest — refinancing a 4.75% mortgage down to a 3.75% rate, for example — it’s going to be worth the closing costs and effort. However, farther down we’ll explain in more detail how to determine when it makes sense to refinance your home.
Is Now a Good Time to Refinance My Home?
Of course, everyone’s personal circumstances vary, so only you can really answer that question. But based purely on how current interest rates compare to historical trends, it may very well be an ideal time to refinance your home.
While the Federal Reserve raised rates last year for the first time in a decade, mortgage rates are still near record lows — and some experts expect them to stay there for the next year or so. In its forecast for the second half of 2016, Kiplinger’s says it expects mortgage rates to hover around 3.5% into 2017 in the aftermath of Great Britain’s vote to leave the European Union.
Remember that you can always take interest-rate predictions with a grain of salt — even the savviest economist will tell you they can’t be certain what will happen. So make sure you ultimately base your decision on your own financial readiness to refinance.
Why Should I Refinance My Mortgage?
You probably remember all the hoops you had to jump through to get your original mortgage — why would you want to do that again if you aren’t even moving? There are several good reasons, all of which could leave some more cash in your pocket:
- To get a lower interest rate: This is the most popular (and most obvious) reason to refinance your mortgage. Rates remain near historic lows, and obtaining a new loan with an APR just a percentage point or two lower than your old one can mean substantial savings, both monthly and over the long haul. And if your credit has improved substantially since you took out your original mortgage, that could also help you qualify for a much better rate than what you currently have.
- To change your loan term: This typically goes hand in hand with rate refinancing. Changing your loan term (the length of time it will take you to pay off your loan) can affect both your monthly payment and how much you pay over the life of your mortgage. A longer term means you’ll have a lower monthly payment, but will probably pay more interest over the life of the loan. A shorter term typically means a higher monthly payment with less interest owed over the life of the loan. Note that if you score a particularly great rate, you might be able to shorten your loan term without raising your monthly payment. Likewise, you could potentially extend your loan term without adding to the total interest owed.
- To change your loan type: Perhaps your current mortgage is a 5/1 ARM, or adjustable-rate mortgage. You had a low fixed rate for five years, but now you’re nervous your interest rate is going to rise in the coming years and would rather switch to the security of a conventional fixed-rate loan that you can more easily budget for.
- To get some cash: “Cash-out” refinancing lets you get a mortgage loan for more than what you actually owe and keep the difference to spend on whatever you want. This is a common alternative to a home equity loan or home equity line of credit for homeowners who want to convert some of their home’s equity into cash.
When Does It Make Sense to Refinance My Mortgage?
An old refinancing rule of thumb says it makes sense to refinance when you’ll be able to get an interest rate that’s at least 1% to 2% lower than the one you’re currently paying. But many experts caution that this rule, though appealingly simple, discounts too many extenuating factors.
For instance, what closing costs and fees are attached to your loan, and how long will it take you to break even? How long do you plan to stay in your home? Are there any tax implications, such as a lower mortgage interest deduction? Here are the big questions you need to ask yourself before refinancing your home.
Refinance calculator: How long will it take you to break even?
This is the million-dollar question when it comes to refinancing. Getting a mortgage is time consuming and costly, whether you’re buying a house or refinancing your existing loan. Besides wrangling all the paperwork — you’ll have to dig up your tax returns, bank statements, and pay stubs — you’ll pay closing costs all over again, too.
A 2015 Bankrate survey found that closing costs on a $200,000 mortgage averaged $1,847 nationwide. That number includes some common third-party fees, such as appraisals and credit checks, but excludes some others, such as title insurance.
To see whether it’s worth refinancing, you’ll want to use a mortgage refinance calculator like the one below to figure out how long it will take to recoup those closing costs.
As an example, let’s say I originally got a 30-year mortgage for $250,000 five years ago, at a rate of 5%. Now, I’m looking to refinance the balance of $229,000 at a rate of 3.75% for 25 years.
Using the calculator below, assuming $2,500 in closing costs, I could lower my monthly payment by $165 without extending my overall loan term, and save more than $47,000 in interest over the life of the mortgage. However, it would still take me 11 months before I “break even” on the closing costs and start to realize those long-term savings.
How long will you stay in your house?
That leads directly to the next question: Will you stay in your home long enough to break even and reap some of those savings?
If moving is out of the question for several years, or you expect to recoup your closing costs relatively quickly, then it’s probably worth pulling the trigger. But if there’s a good chance you might sell your home before you break even on the closing costs and start to enjoy the savings, refinancing may not make much sense.
Four Tips for a Smooth Refinancing Process
No doubt you’ll want to get the best mortgage refinance rate that you can snag — be sure to check out this post for more in-depth advice on shopping around for rates and comparing loan terms. Here are some tips to optimize you refinancing process:
Check with your original lender first
Shopping around for the lowest rate is smart, but once you get a sense of what’s out there, go back to your original lender. They probably want to keep you as a customer, so give them the chance to match a competitor’s rate.
You may also find that your original lender won’t require you to pay some the fees often associated with refinancing, helping your bottom line and break-even point.
Ever since the subprime mortgage crisis, banks are much more meticulous about checking and double-checking all of your financial documents before refinancing a mortgage loan. Experts suggest treating refinancing just like you would if you were buying a house all over again.
Among the paperwork you’ll likely need: At least the past two years of tax returns and W2 forms, recent statements from bank and investment accounts, recent pay stubs, and anything else that proves your income. Gather all documents in advance, and don’t be surprised if you’re hounded for more.
Even if you’re organized, expect a lengthy process: You’ll probably need at least a month to refinance a mortgage.
Look at more than your monthly payment
If you already have a 30-year mortgage, it might be tempting to refinance into another 30-year term simply because of a tantalizingly low monthly payment. But if you want to save money over the life of the loan (and have it completely paid off sooner), choose the shortest term you can comfortably afford. At the very least, try not to tack on any additional years when you refinance.
While it’s most common to use a lower interest rate to reduce your monthly mortgage payment, you can also take advantage of a low rate to reduce the years left on your loan.
Using the example above, I would save $165 a month and more than $47,000 in interest over the next 25 years of the loan if I refinanced my remaining mortgage balance from 5% to 3.75%. However, if I refinanced it into a 20-year loan instead, I’d pay just $16 more a month – and be mortgage-free a full five years earlier, saving almost $75,000 in interest.
Before you commit to a loan term, use a refinance calculator to play with the numbers and see how term, interest rate, and closing costs factor into what you’ll pay monthly and over the life of the loan.
Be careful of ‘cashing out’
As I mentioned above, a cash-out refinance lets you nab a chunk of the equity you’ve built up in your home by refinancing your existing mortgage with a larger one. You get to use the difference for whatever you want, whether it’s a kitchen remodel or to pay for your kid’s college education.
The pros and cons of cash-out refinancing are similar to those of obtaining a home-equity loan or home equity line of credit. The major pro is that you’ll be getting potentially much-needed cash at a much lower interest rate than if you were to use a credit card or obtain an unsecured personal loan.
However, remember that you’ll be paying for that infusion of cash in the form of higher monthly mortgage payments for the entire term of your loan. If that strains your budget in any way, a cash-out refinance is not for you — especially since you could lose your home if you fall behind on your mortgage.
And if the subprime mortgage crisis taught us anything, it’s that being underwater on your mortgage (where you owe more than your home is worth) is not a good place to be. Anytime you tap your home equity, you increase the odds that this could happen.
Speaking of underwater homeowners, even they may be able to refinance at a lower rate through President Obama’s Home Affordable Refinance Program, established in 2009 in the wake of the housing crisis.
If you purchased your house prior to May 31, 2009, and you have less than 20% equity in your home, you’re current on your payments, and your mortgage is owned by either Fannie Mae or Freddie Mac, you may be able to take advantage of this government program to refinance your loan at a lower rate — even though most banks wouldn’t otherwise allow you to do so.
The HARP program has been extended in years past, but is due to expire at the end of 2016. Check your eligibility and learn more about the program on the government’s HARP website.
Refinance a Mortgage and Save? Maybe, If You Do Your Homework
“Refinancing” has become something of a financial bandwagon. Resist the temptation to hop on until you’re sure it makes sense for you. High closing costs, lengthy waits, and the temptation to consider monthly costs, not overall savings, can lead to some major pitfalls for anyone who hasn’t done their research.
To learn more about how to save the most you can when you refinance mortgage rates, check out my post on How to Get the Best Refinance Rates.