A home mortgage refinance can look appealing to homeowners who are looking to reduce their monthly mortgage expense, but is it worth it? The answer is: it depends.
Everyone has a unique mortgage and financial situation, refinancing can either save you money or can cause you a lot of hassle and headache. Although the promise of lower interest rates and a smaller monthly mortgage payment may sound great at first glance, it’s important that you understand the full picture.
In this article, we’ll cover when it’s worth it to begin the home refinancing process and when you should avoid it or hold off for more favorable conditions.
In general, it makes sense to refinance your home if you can save money on your existing mortgage. Here are some situations when that may be a reality:
If you’re thinking of refinancing your home, the catalyst may be that you saw on the news that mortgage rates were on the decline.
Mortgage rates fluctuate often as they’re impacted by a variety of factors. Market movements, inflation, U.S. Federal Reserve monetary policy, the economy, and global factors all play a role in mortgage rates.
If mortgage rates fall lower than the rate you secured when you purchased your home, you may be able to refinance to take advantage of the lower interest rates. This is known as rate-and-term refinance and it’s when you refinance your mortgage for one with a lower interest rate and the same term.
As a general rule of thumb, home lenders recommend refinancing for a lower rate when the new rates are at least one to two percent below your current rate.
That being said, each borrower’s financial goals and needs are unique. For example, a one percent interest rate reduction may net significant savings on a $1 million mortgage but will be less impactful for a $100,000 mortgage.
The next scenario in which you may be interested in going through with a home refinance is when the value of your home has gone up.
This is called a cash-out refinance and it allows you to take out a new mortgage that’s larger than what you previously owed, and in turn, you’ll receive the difference in the form of cash. This is especially beneficial if you have any other high-interest debt you’d like to pay off.
A cash-out refinance is an alternative to a home equity loan—a scenario in which you borrow additional money against the equity you have in your home.
When your home’s value increases, you may be able to refinance your mortgage for more than the balance of your mortgage.
For example, let’s say you took out a $100,000 mortgage three years ago on a $140,000 home ($40,000 went to your down payment). After making your regular mortgage payments for three years, you now only owe $70,000 on your mortgage.
If the property market in your area has gone up, the value of your home has increased with it—making it worth $190,000, you may be able to refinance for more than the $70,000 balance on your mortgage. If you end up refinancing $100,000, you can then take the $30,000 cash difference and use it to pay down debt, make home improvements, buy a new car, and so on.
The most important thing to keep in mind about cash-out refinancing is that you need to be sure to use the money responsibly. The money you receive in cash is part of the loan, so you’ll be paying that back with the rest of your mortgage.
Another situation in which you may consider a home refinance is if you’ve significantly improved your credit score.
Your credit score plays a substantial role in determining your mortgage rate. Theoretically, the higher your credit score, the lower your interest rate should be.
If you’ve improved your credit score even by 100 points since you first opened your mortgage, you could now fall withing a new credit range that would qualify you for a lower rate.
If you chose an adjustable-rate mortgage when you opened the loan, and now interest rates are on the rise, it may be a good idea to consider refinancing your loan and converting it to a fixed-rate mortgage. A fixed-rate mortgage gives you peace of mind that you’re locked in with your rate, regardless of rate fluctuations in the future.
If you’re thinking about a home refinance soon, here are a few tips to help you make sure it’s worth it:
Refinancing your mortgage can be a great financial move if it reduces your monthly mortgage payment, shortens the term of your loan, or helps you to build equity faster. When done correctly, it can also be a valuable tool to help bring your debt under control.
Before you begin the refinance process on your home, be sure to take a careful look at your current financial situation and do a deep analysis of the housing market, interest rates, how much money you’ll be saving and if it’s worth your time and effort.