Mortgage rates have been low for a long time. You've probably thought about refinancing your mortgage but aren't sure if now is the right time. Regardless of how long you've owned your house, this decision should be considered carefully. It's not cheap to refinance your mortgage, so let's walk through the key factors to consider when deciding to refinance your mortgage.
How Long Will You Own Your House?
Do you remember when you bought your home? Besides the down payment, there were a lot of extra closing costs. When you refinance your mortgage, you'll have to pay most of these closing costs again. Depending on where you live, this can amount to somewhere between two and five percent of the mortgage. For example, a $350,000 house with a $280,000 mortgage could have refinancing costs between $5,600 and $16,800.
If you're planning to sell your home within the next five years, chances are you won't recoup the cost of refinancing your mortgage. The number of months needed to break even is easy to calculate. There are lots of mortgage refinance break-even calculators available online.
- Estimate your closing costs for refinancing.
- Calculate your monthly savings.
- Divide closing costs by monthly savings to find your break-even date.
How Much Will It Cost to Refinance Your Mortgage?
The general rule of thumb is that refinancing makes sense when you can receive a one percent or more drop in your interest rate. Ideally you want to recover closing costs within three to five years but the cost of refinancing varies significantly. Some states levy more taxes. In rare instances you may find a lender who's willing to waive and/or cover some of these costs.
Asking each potential lender for estimated closing costs is a great way to compare them. It's worth your time given the significant costs to refinance. Here are estimated costs to refinance a $350,000 house with 20% down in central Florida. The appraisal cost was high but the lender gets to pick the company.
|Closing Cost Items||Refinance Costs|
|Points (Typically 1% or less)||$2,800|
|Title Search & Closing Fees||$600|
|Title Insurance (Lender & Owner)||$1,000|
|Total Closing Costs (2.5% of Mortgage)||$6,875|
|Homeowner's Insurance (4 months in escrow)||$400|
|Property Taxes (9 months in escrow)||$2,700|
|Total Cost of Refinancing a Mortgage||$9,975|
Note: Effective August 1, 2021, the Federal Housing Finance Agency is eliminating the half point “Adverse Market Refinance Fee”. This fee went into effect December 1, 2020. The fee was added to all mortgages being refinanced, to cover projected losses due to the Covid-19 pandemic. Fortunately most homeowners using forbearance during the pandemic have exited the program so the extra fee is no longer needed.
Best Reasons to Refinance Your Mortgage
Homeowners have many reasons for refinancing their homes. Some of these are good ideas while some reasons don't feel right, although everyone's personal story is different.
Here are the most common best and worst reasons to help you decide what's right for you.
- Get a Lower Interest Rate – This will save you money over the life of your mortgage. It may or may not lower your monthly payments depending on the type of financing you choose:
- Lower payments – happen when you get a lower interest rate on a 30 year mortgage. Both a lower rate and a lower amount (current principal) give you this savings.
- Higher payments – can happen with a lower rate if you decide to pay off your mortgage faster, typically in 15 or 20 years.
- Lower risk – will be achieved if you refinance to switch from a variable rate mortgage to a fixed rate. Your monthly payment may be higher or lower depending on your current variable rate and new fixed rate.
- Eliminate PMI by Refinancing Your Mortgage – This is another way to reduce your monthly payments if you now have 20% equity in your house. Commercial mortgage lenders are supposed to drop this payment when you reach 22% but this might be a challenge if you want to use an increase in home value to prove higher equity.
- Cash-Out Refinance to Consolidate High Interest Debt – This might make sense if you've got significant credit card debt at a much higher interest rate. Be aware, though, that you can't deduct the interest you pay on the cash-out amount exceeding your current loan balance.
Think Twice Before Refinancing to …
Refinancing isn't free, far from it. That's why you should give careful consideration to refinancing your mortgage for the following reasons:
- Cash-Out for Binge Buying – With house prices skyrocketing, you might think you're rich. Now is not the time to tap into your home equity for things you want but don't need. This includes a fancy new car, an expensive vacation or questionable investments. Remember, you'll still be on the hook to repay this money and risk losing your house if you can't make higher mortgage payments in the future.
- Cash-Out Refinance to Make Home Improvements – It might be tempting to use home equity to remodel your kitchen, a bathroom or add a swimming pool. The challenge is whatever you do will cost a lot more when you add in all the refinancing costs. Try breaking down improvements to affordable projects you can do out of current cash flow.
- Refinance with More than Half Your Mortgage Paid Off – With each monthly payment, you pay less interest and more principal. Refinancing your current balance for another 30 years will lower monthly payments but you'll increase the total interest paid over the life of the two loans.
|Year 1, Month 1||$1,175.00||$482.00||$693.00|
|Year 5, Month 1||$1,175.00||$557.68||$617.32|
|Year 7, Month 10 (Less Interest)||$1,175.00||$588.85||$586.15|
|Year 10, Month 1||$1,175.00||$646.84||$528.16|
|Year 20, Month 1||$1,175.00||$870.21||$304.79|
|Year 30, Month 12||$1,734.93||$1,730.65||$ 4.28|
- Refinancing to Pay Off Loan Faster – You might want to pay your mortgage off faster but a shorter mortgage term, such as 15 years, reduces your flexibility to handle other obligations. Another option to achieve this goal is to increase your monthly payment which will pay down your principal faster. This allows you to drop this extra payment if you need the money later for something else or if circumstances change.
Now that you've reviewed all your options, you probably have a better idea if it makes sense to refinance your mortgage. If you want to move forward, here's an easy to use mortgage calculator to help you play with the numbers.
Best of luck with all your homeowner decisions now and in the future.