Mortgage rates have been trending down and the US National average for a 30-year mortgage hit 3.45% last week, a full percentage point lower than where it was the same time last year (4.41%). A lower rate means lower payments. If you bought a house today you’d pay $166 less per month on interest versus a year ago.
But, assuming you already have a home, the drop in interest rates is leading many people to ask themselves if now is the right time to refinance their existing mortgage.
There are many reasons why a homeowner may want to refinance a mortgage, locking in a lower interest rate is only one of them.
Getting a lower payment.
This is typically the biggest driver towards refinancing. By getting a new mortgage at a lower rate you can lower your monthly payment. With this type of refinance you are usually extending the amount of time and interest you will end up paying on your home.
Extracting equity out of your home.
By refinancing you can take advantage of property appreciation and/or your principal payments on your home and cash out some of the equity you’ve built up to use for home improvement projects or other uses.
Reducing interest paid.
Refinancing at a lower interest rate can save you on the total interest paid over the life of the loan.
Refinancing to a shorter loan term.
A shorter loan term can help you save on the total interest paid over the life of the loan albeit with higher monthly payments. Lower interest rates can help bring the monthly payments for a shorter term loan within reach.
Locking in a fixed rate.
Many adjustable rate loan options exist with the interest rate fluctuating over the life of the loan. Locking in at a fixed rate can give you peace of mind that your loan payments will not rise if interest rates do in the future.
The refinancing process can look much like the process you went through when first buying your home and applying for a loan. Your mortgage lender will look at your credit score, income, savings and may ask for a new appraisal of the property. You can expect to pay closing costs on the new loan that can range from 1%-5% of the cost of the loan depending on the lender. Before starting the process, ask yourself a few questions first.
How long do I plan to stay in this current home?
This is a big one. Whether you are living in your forever home or if you plan to move within a few years will have a big effect on refinancing being a good financial decision. A lower monthly payment may seem enticing, but you need to run the numbers to see if you will break even after factoring in the closing costs at the beginning of the loan.
How long do I have left on my current mortgage?
The longer that you pay on a loan the more of your payment goes towards the principal versus interest. In the beginning most of your payment goes to interest and at the end the majority goes towards the principal. If you are closer to the end of your loan there may not be as much of a benefit to getting a lower interest rate. People also derive psychic income from paying off a large debt, so if you are close to having your mortgage paid off you may feel better having it gone rather than extending it and getting a lower payment.
Am I still paying PMI on my loan?
If you have to pay for private mortgage insurance on your loan because you borrowed more than 80% of your home’s value you may be able to get rid of PMI on your new loan by refinancing. You also may be able to stop paying PMI on your current loan if your home has appreciated and/or you’ve built up enough equity in your home. Usually this will require a new appraisal so check with your mortgage lender to be sure.
How much equity do I have in the home?
If you want to get cash out during a refinance then you will need to have the equity in your home to do so. Also, many lenders like you to have at least 80% equity in your home before going forward with a refinance.
What interest rate do I think I will qualify for?
If your financial situation has changed significantly since you applied for your original loan; making more money, paid off debt, increased your credit score. You could qualify for much better loan terms during your refinancing.
Do I have any big financial decisions coming up soon?
Don’t forget to consider any big life decisions you may have coming up. If your job situation is up in the air and you might have the opportunity to take a role that requires a move or more travel, then sitting tight might be the safest decision for now. Or if you thinking of starting a family or a business and your income may fluctuate in the near future, then it may be the right decision to take advantage of your current stability to lock in a new loan now at a lower rate.