When you take out a mortgage, you’re required to repay both the principal amount on the loan and the interest payments, which are based on a certain rate. If you find that you’re having a difficult time keeping up with your mortgage payments, or if you simply want to lower them, then it could make sense to refinance your home loan with a new rate.
When you refinance, you effectively swap out an existing loan for a new one. In the case of a mortgage, your new lender pays off your previous home loan, and then you begin making payments on your new loan. Here, The Motley Fool offers four factors to consider if you’re thinking about refinancing.
1. You can handle the closing costs
Just as you pay closing costs when you take out an initial mortgage, you also are liable for closing costs when you refinance. In some cases, those costs can be substantial. So, you’ll need to make sure the savings you reap by lowering your monthly mortgage payments are enough to justify the cost of refinancing.
2. You’re planning on staying put
You generally shouldn’t refinance your mortgage unless you’re able to reduce your current interest rate by at least 1 percent. But you’ll also need to make sure you’re planning to live in your home long enough to recoup the money you spend on closing costs and come out ahead on your monthly payments.
If you’re planning to move in a year or two, refinancing may not make sense.
For example, imagine that by refinancing you’re able to shave $150 a month off of your current mortgage payment. That’s some nice savings. But if you spend $3,600 in closing costs in the course of refinancing, it’ll take you two years to break even—so if you’re not planning to stay in your property that long, it’s not worth it.
3. You’re OK with resetting the clock on your loan
If you take out a 30-year mortgage at age 35, and then refinance five years later to another 30-year mortgage, you’re looking at paying off that debt at age 70 rather than 65.
That could be problematic if your goal is to pay off your mortgage before retirement. One strategy you might employ is to refinance to a lower interest rate, but then pay the amount you save each month into your mortgage’s principal. That way you’ll shorten your new repayment period.
4. You have better credit than when you originally applied for a loan
It doesn’t pay to refinance your mortgage if your credit isn’t much better than it was when you first applied for your home loan. You’re unlikely to get a much lower rate if your credit score hasn’t budged unless rates have dropped significantly across the board.
If your credit has improved since you took out your mortgage, and you’re able to lower your interest rate substantially, then refinancing your home loan could make sense, especially if you’re planning to keep that property for a number of years.
