People often wonder if they should refinance their mortgages when they start seeing newscasts that talk about the great buyer’s market and the falling mortgage rates.
But does this mean you should immediately jump on the band wagon and refinance your current mortgage?
Not necessarily. Make sure you have all your ducks in a row before jumping into the pond. Refinancing isn’t always an option or the right choice; while at other times it’s also the best choice. Don’t go about the decision blindly and don’t be afraid to find help.
You can contact a realtor to ask for some guidance towards who to ask the right questions to. Make sure you work with an agent you trust. Some can guide you with simply getting you in contact with a finance company they know and work with; while others can even help you through the process with minimal to no fees involved.
First off in order to refinance your mortgage most mortgage companies require a minimum of 10% equity in your home. If you don’t have the equity in your home you’re going to end up having to pay the difference up front to bring your equity to at least 10%.
This means that often you end up having to come up with more money as an additional down payment as if you’re buying the home all over again. That’s generally not an appealing option for most people; not to mention it kind of defeats the reason for refinancing in general, which is to more money.
Most mortgage companies won’t even consider refinancing if you have any late payments due. Most require that you’ve had no late payments for at least the past 12-15 month period. Your credit score is important. Before you even think about refinancing you will want to pull your credit report and first, see if it’s accurate. Next you’ll want to repair any problems or negative points on your report. If your score is extremely negative you are most probably not going to be approved for a refinance loan.
What to Know
Compare Rates – Always compare the rates of various mortgages but it’s not just that cut and dry. You must take into consideration such things as points you may have to pay in order to refinance, refinancing fees, and other fees that may be placed upon you should you decide to refinance. Be sure you also know up front what you must pay for. You may be surprised to find that the lure of some lower rates also come with surmountable additional expenses that can be very cumbersome to take on.
The 2% Rule – The 2% Rule applies when the refinancing interest rate is 2% lower than your current rate you can make up the difference in any loan costs, assuming you have no plans of moving immediately. With the 2% rule you will save a reasonable amount in interest through the lifetime of the loan, while taking advantage of no-cost or low-cost loan options. The down side to these loans is that they are usually slightly higher in interest rates than the current lowest rates and options are often limited, especially if the current economic situation is unstable. The plus side is that you save on interest rates, enough to make a difference, you aren’t socked with tons of financing fees, points and costs usually associated with refinancing and you’ve lowered your rate by 2%. This 2% rule is actually a fairly “old fashioned” method of refinancing and while it still does apply to many situations, you can actually have situations where, especially with larger loans, you can save a substantial amount of money with as little as a half-percent. No matter which case, you always need to take into consideration if the amount you will save in the long run is worth the cost of refinancing.
Know Your Future Plans – You have to know your future plans. While none of us has a crystal ball that can tell us things like medical emergencies that can change our life or job changes, etc. but we can plan the future and have a general idea of what our plans are going to be. A general rule of thumb is that if you don’t plan on staying in your home for a lengthy period of time, it’s generally not worth refinancing your mortgage. Between the costs involved and the time and effort it takes you will never make back the money you’ll put out unless you plan on keeping your home for a longer period of time. Also, if you’re not going to be able to compensate for the costs of refinancing your mortgage within a reasonable amount of time you’re going to want to say “no” to the idea of refinancing. This is where comparing costs to savings and the end results should confirm what your decision is regarding refinancing.
The Easiest Way to Compare – The easiest way to compare whether it will pay off to refinance your current mortgage or stay where you are is a very basic rule of thumb. Like all financial decisions they should never be taken lightly. You should always seek professional guidance when making a decision as large as refinancing a mortgage.
That being said you can also have a very basic way to help you determine a first plan of action and making the decision if the refinancing is worth it. Take the total cost of refinancing (such as closing costs on a good faith estimate) and divide that by the amount of you will save each month on your payment. This will tell you how long it is going to take you to just break even with the costs of refinancing. After that, any amount after that is money you are truly going to be saving.
Here’s an example: Let’s say your refinancing costs you $4,000 to refinance a loan that is going to lower your monthly payment by $250. This means that 4,000 divided by 250 is 16; telling you it’s going to take 16 months of making payments just to break even on the $4,000 costs to refinance. That’s under 2 years to pay off the costs of refinancing; if you’re considering staying in the home you’re in for over 2 years it definitely would pay off to refinance your loan.
Now let’s look at another scenario. If refinancing is going to cost you $6,500 but only lowers your payment by $100 a month; it’s going to take you 65 months (over 5 years) just to pay off the refinancing charges and break even. As logic would tell you, this is probably not a smart idea. The problem is that many people only see the quick $100 less per month and that impresses them that their mortgage payments become $100 lower. But the reality is, you’re really not getting anywhere when you truly look at the numbers and figure what it’s going to take you to break even.
The Final Decision
The final decision comes down to many factors and is ultimately yours to make. You have to figure out the benefits of the actual refinancing in order to decide if it is worthy. Use the quick, basic figuring we explained of dividing the total cost of refinancing by the amount you are saving each month on your monthly mortgage payment. This will give you a quick look and answer to whether it is even worth taking any more time to consider.
Consult with a financial advisor or lender, but don’t always believe the numbers until you’re sure of what you’re seeing. As we showed you, the lure of a $100 a month less on your mortgage payment may seem wonderful until you realize it’s going to take you 35 years to pay the amount of the refinancing back. It’s always great to see a savings up front but the true savings comes when you figure out how much you are actually saving in the long run.
Don’t be bullied into doing something you’re uncomfortable doing. Go with your own instincts, judgment & gut feelings.