Who doesn't love the idea of saving a few bucks, especially when it comes to paying a mortgage? Considering the fact that mortgages are one of the biggest expenses that consumers have, it would be extremely helpful to be able to slash that payment, and mortgage refinancing can make that happen.
When timed right, mortgage refinancing may be a great way to save a bundle over the life of a mortgage. The question is, when is it the right time to take advantage of this mortgage product?
What is Mortgage Refinancing?
Mortgage refinancing involves taking out a new mortgage to pay off and replace the current mortgage on a home. Usually, the new mortgage has a lower interest rate than the mortgage being replaced, and the terms are typically different as well.
It's common for people to confuse mortgage refinancing with a second mortgage; however these are not the same thing. While a mortgage refinance replaces the initial mortgage, a second mortgage is taken out in addition to the first mortgage without replacing it. Mortgage refinancing basically involves providing you with the funds needed to completely pay down your first mortgage (or any other mortgages attached to your home) in an effort to take advantage of a better rate and terms.
The most common reason — and the biggest benefit — to refinance a mortgage is to take advantage of a lower interest rate. If the rate on the new mortgage is much lower than that of the original mortgage, you can save quite a bit of money and will therefore have a lower monthly payment.
However, much like taking out a first mortgage on a home, you'll be responsible for paying closing costs associated with the new replacement mortgage. That includes costs associated with title insurance, appraisal fees, underwriting fees, and so forth. Basically, you're paying for all the same closing costs all over again. While the lender might be open to waiving some of these fees, you'll still likely be stuck paying the majority of them.
That said, the amount of money you could potentially be saving by getting a much lower interest rate might more than make up for these initial upfront costs. It's important to do the math before you decide to opt for mortgage refinancing.
So, when is it the right time to refinance your mortgage?
When Mortgage Rates Are Expected to Rise Soon
Interest rates are still pretty low, but they've already been on the uprise over the recent past, albeit very gradually. With rates being as low as they still are, many homeowners are opting for mortgage refinancing in order to lock into a lower rate than they may have agreed to when they first took out a mortgage.
The best time to refinance a mortgage is when rates are still low but are expected to rise in the near future. By locking in at a low rate today, you can beat the increase that may eventually come.
Considering today's current interest rate environment, now might be a good time to refinance a mortgage, as rates are still low and anticipated to increase in the near future.
When You Have at Least 20% Equity in Your Home
Mortgage refinancing is typically best for homeowners who have built up a significant amount of equity in their home. The equity is basically the difference in the current market value of the property and the amount of the loan still outstanding. If you have at least 20% equity in your home, it might be a good time for you to refinance your mortgage.
The reason why your home's equity is so important to consider is because it could mean the difference between paying mortgage insurance or not. Lenders typically require mortgage insurance on home loans that are more than 80% of the property's value in order to provide them with protection in case you ever default on the mortgage.
This type of insurance can be pretty expensive and can offset any savings that you may have realized after refinancing. If you do have less than 20% equity in your home, make sure you include the cost of insurance in your calculations before refinancing your mortgage.
When the Savings Justify the Refinance
There's a lot of math that will need to be done before deciding whether or not a mortgage refinance makes sense right now. As mentioned earlier, closing costs will need to be factored into the equation to help determine the net savings that can be realized. Generally speaking, homeowners spend anywhere between 3% to 6% on the loan amount on closing costs. Before refinancing, it's important to see how long it will take to fully repay these closing costs before savings start to kick in.
The length of time that you plan to sell and move out of your home will also need to be considered in this equation. For example, if your monthly payments are reduced by $200 every month as a result of a refinance at a lower interest rate, it would take you just over two years (25 months, to be precise) to recoup $5,000 spent in closing costs ($5,000 ÷ $200). If you sell your home before those two years are up, you would be losing out instead of saving. On the other hand, if you plan to stay put for the long haul, you could realize significant savings.
When You're Still Early in Your Mortgage
When you refinance your mortgage, you're essentially extending the loan period. If you agree to a 30-year amortization period, for instance, you're basically pushing out your mortgage another 30 years. If you're young and are still early in your mortgage, this might not be a major issue. But if you're in your 50s or older and have already been paying a mortgage on your home for 15 years, now might not be such a good time to start all over.
That said, you can always choose a much shorter mortgage period instead of 30 years, such as a 10- or 15-year mortgage. However, the shortened loan period will come with higher monthly mortgage payments compared to a longer loan period, despite paying a lower interest rate.
Mortgage refinancing can definitely be a great way to help you save a lot of money over the life of your home loan. But only after detailed number crunching and a careful look at your current finances and personal situation should mortgage refinancing be considered. Speak with a seasoned mortgage broker to find out if now is the right time for you to tap into this mortgage product.