Know when to refinance — and when to stand pat
Reasons to consider refinancing
- Get a lower interest rate
- Shorten the term of your loan
- Lengthen your loan term, lowering your monthly payment
- Receive needed money from a cash-out refinance
The processes of buying a house and finding the right mortgage can be frustrating. That frustration can boil over when, a few months or a few years after making such a huge financial investment, mortgage interest rates drop to levels well below what you are paying, or when you suddenly find yourself having a difficult time meeting your monthly payments.
Fortunately, there are options available, including refinancing your mortgage. With a refinance, homeowners can pay off their first mortgage and obtain a new one with better terms, rates or monthly payments. Figuring out when to do this, however, can be another frustrating process.
When should I refinance?
Before looking seriously at refinancing your mortgage, be sure you know all of the details of your current mortgage. Without knowing your loan's terms, you could make a decision that isn't as beneficial as it seems on the surface. If you are armed with all of the necessary information, however, you may find several reasons to refinance your mortgage.
One of the biggest reasons to refinance is to get a lower interest rate. Depending on the amount of your loan, lowering the interest rate by one percentage point could reduce your mortgage payments by $100 or more per month.
If you have an adjustable-rate mortgage and are concerned that your rate may climb higher than you would like, refinancing could be an attractive option. Especially when interest rates are low, refinancing to a fixed-rate mortgage can keep your monthly payments low while also eliminating the risk of a sudden rate increase.
Refinancing also can be an effective way to change the length of your mortgage. If you find it difficult to meet your monthly payment, refinancing to a new 30-year mortgage could significantly lower that payment — although you will end up paying more interest over the duration of your loan. You also could use a refinance to shorten the term of your loan. If that shorter term is combined with a considerable interest-rate drop, your monthly payments could stay similar, although you would pay less interest over the course of the mortgage and have it paid off sooner.
When should I avoid refinancing?
If none of the above scenarios applies to you, it is likely that you won't be interested in refinancing your mortgage. Even if the above do apply, however, there are other factors to consider.
If you plan on selling your house soon, it may be best to avoid a refinance, as it is likely the savings you get on your monthly payments won't make up for the fees and closing costs you will pay to obtain the refinance. Similarly, if your current mortgage has a prepayment penalty, your refinance savings may not make up for the fees you would be required to pay to get out of your current mortgage.
The Federal Reserve also recommends avoiding a refinance if you have had your current mortgage for a long time. As your mortgage nears its end, more of your monthly payment goes toward the principal balance, and less toward interest.
"By refinancing late in your mortgage, you will restart the amortization process," the Fed says, "and most of your monthly payment will be credited to paying interest again and not to building equity."
A cash-out refinance can be an attractive option for people who have equity in their homes and are in need of a sudden influx of cash. This does reduce the amount of equity you have in your house, however, meaning you would receive less money when you sell the home. Because of this, it is best to discuss cash-out refinances — and, really, any refinance — with a lender and a financial adviser.