Should I refinance my mortgage? It’s a common question among homeowners with mortgages — especially when interest rates are rising.
Refinancing your mortgage can lower your monthly payments, decrease the total amount you pay back, or even put some extra cash in your pocket — but it’s not for everyone.
Whether or not mortgage refinancing is right for you depends on market conditions, your goals, your credit score, and the type of mortgage loan for which you’re qualified.
Let’s take a closer look at how refinancing your mortgage works so that you can better gauge if mortgage refinancing is right for you.
What is a mortgage refinance?
Mortgage refinancing entails taking out a new mortgage to replace your current mortgage. The new mortgage loan allows you to pay off the remaining debt on your old mortgage; you can then pay back the new mortgage based on the new terms.
People often refinance their mortgages to take advantage of lower interest rates.
When should I refinance my mortgage?
There’s no cut-and-dried rule about when to refinance your mortgage. It depends on what you’re trying to achieve through the mortgage refinancing.
Some reasons that refinancing your mortgage might be good for you include:
“If you’ve had an increase in income and can now afford a higher monthly payment, you might consider refinancing into a shorter payment term in order to save in the lifetime costs of the loan,” explained Daniel Benitez, a San Diego-based Loan Officer.
Identifying your goals in a mortgage refinance will help you make the right choice for your particular situation.
Types of mortgage refinancing loans
Borrowers can usually choose between two types of mortgage refinancing loans:
Here’s an example that shows the benefits of a rate-and-term mortgage refinance:
Ten years ago, Florence took out a $200,000 30-year fixed-rate mortgage at a 6% interest rate, on a home valued at $270,000 at the time. She’s consistently made the monthly mortgage payments — about $1,200 — and still owes about $167,000. She has 20 years remaining on her mortgage.
Florence refinanced for a new 20-year mortgage for the remaining $167,000, this time with a 4.5% interest rate. Her new monthly mortgage payment is now about $1,060. Even taking into account the $2,000 in fees she paid for the new mortgage loan, she’ll pay nearly $35,000 less in total at the end of the 20 years than if she kept her original mortgage (assuming she’s planning to stay in her home that long).
Your conventional cash-out mortgage refinance can’t be more than 80% of your home’s value (75% if it’s a second or investment home). Consider Irene, who owns a house valued at $200,000 and has $100,000 remaining on her current mortgage. She gets a cash-out mortgage refinance for $160,000, 80% of her home’s value and the maximum available to her. After she pays off her home’s current mortgage balance, she’s left with $60,000 in cash (she uses some of that to cover the closing costs on her mortgage refinancing, so she winds up with a few thousand dollars less).
Of the two, cash-out mortgage refinancing generally comes with tougher terms and slightly higher interest rates. But for qualified homeowners who need extra money, a cash-out mortgage refinance may be a good choice.
Considerations before refinancing your mortgage
Lots of factors contribute to determining if mortgage refinancing is right for you, and also the type of mortgage refinancing for which you’re qualified. Among them are:
If a mortgage refinancing interest rate is significantly lower than your current mortgage rate, you may be able to get a shorter term without affecting your monthly mortgage payments too much. This costs you less because you’ll save in total mortgage interest.
A mortgage refinance calculator — you can find many online — will compute potential savings of a new term versus the current term of your mortgage.
“The payback on the closing costs shouldn’t exceed 24 to 30 months” advised Robert E. Tait, a mortgage banker at Allied Mortgage Group.“The borrower should plan to stay in their home for at least 12 months longer than the payback period” to make a mortgage refinancing worth the costs involved.
Keep in mind that there’s more to calculating break-even time than simply dividing your closing costs by any reduction in your monthly payment. You also need to consider the mortgage repayment term.
If you refinance your mortgage into a loan with a shorter repayment term, your monthly mortgage payment may increase, but your break-even time will be shorter than if you reduce your monthly mortgage payment. That’s because you’re getting a better mortgage interest rate and paying your loan principal off faster. Estimating your break-even time can be tricky so look for a mortgage calculator that takes into account the relevant factors.
Some lenders will refinance with less equity for a higher interest rate and if you buy mortgage insurance. Also, the government makes mortgage refinancing programs available to those with government-backed mortgages — such as FHA or VA loans — that may require little or no equity. Some mortgage loans also qualify for the Home Affordable Refinance Program (HARP), a government mortgage refinance program for people who owe as much or more than their homes are worth.
Check with a mortgage professional to see if you qualify.
A no-closing-cost mortgage refinance usually makes sense if you’re not planning on staying in your home very long — say less than five years — or you’ll refinance your mortgage again soon so that extra interest won’t affect you too much. You’ll need to crunch your financial numbers to see if a no-closing-cost mortgage refinance is the best option for you.
In other words, there could be tax implications for borrowers refinancing more than $750,000 in mortgage debt, or taking cash out of their homes that they will not use for improvements (always consult with a tax advisor if you have questions).
>> Related: How to Refinance Your Mortgage Step-by-Step
Is a home equity loan the same as a cash-out mortgage refinance?
Home equity loans or home equity lines of credit (HELOCs) are generally considered second mortgages. They are loans you take out on the equity you have in your home, on top of the primary mortgage you already have.
A cash-out mortgage refinance is not a second loan – it’s a new mortgage entirely that replaces your prior mortgage.
Lenders usually approve home equity loans more quickly than a cash-out mortgage refinance, so you can get cash fast.
If you want to extract cash from your home, you’ll need to examine the pros and cons of a home equity loan versus a cash-out mortgage refinance in your particular situation.