It's hard work finding your dream home and getting the mortgage to pay for it. By the time you've looked far and wide for a house in your price range, and jumped through all the hoops to secure your loan, you'll probably be happy to sit tight for a few years.
But eventually, you might start thinking about refinancing your mortgage, which means taking out a whole new loan in place of the old one. Maybe interest rates have dropped or switching the term could lower your monthly payment. Perhaps you want to remodel your home or need a chunk of cash to deal with an emergency.
Read on to figure out when to refinance a mortgage and if it's the right move for you.
How Refinancing Works
Refinancing your mortgage means going through the loan application process all over again. You'll get a new loan, with a new set of terms and conditions and fees, to replace the old one. The first thing to remember is that this process will cost you between 3% and 6% of your loan principal — so you need to make sure the pros outweigh the cons.
If you decide to go ahead, follow these steps:
- Figure out why you want to refinance.
- Use a refinance calculator to check if it's worth it.
- Contact your current lender and check the conditions on your current loan.
- Reach out to a few other lenders to see if you can get a better deal.
- Agree on an interest rate until you close.
- Close the new deal!
When to Refinance Your Mortgage
Refinancing your mortgage is a big decision. It may take years to get back the percentage of principal it cost you to get the new loan.
You might start thinking about refinancing if any of the following is true for you:
- You want to make lower monthly payments. You can usually do this by changing your interest rate or the term of your loan, but other variables might be at play too.
- You want to pay off your loan faster. Maybe you got a raise and can afford to pay more each month. A shorter term means you pay less interest over the life of the loan.
- You want to switch your interest rate. For example, if you have a fixed-rate mortgage and see interest rates are now much lower, you may want to lock in a lower rate or take your chances on an adjustable-rate mortgage.
- You need equity. That is, you need a chunk of cash.
What is Home Equity?
Equity is the difference between what your house is worth, and what you owe on the mortgage. So if your house is worth $400,000 and you owe $350,000 to your mortgage lender, then you have home equity of $50,000.
Through refinancing, this equity can be turned into a cash asset.
You may choose to access your home equity for all kinds of reasons:
- Remodel your home for your enjoyment or before selling.
- Pay for your child's college tuition.
- Pay large medical bills.
- Go on a dream vacation.
Just remember: you will pay fees to refinance your home. So make sure your reasons to cash in your home equity are going to be worth it in the long run.
Why Do Interest Rates Matter?
Did you know that in the first few years after you get your mortgage, your payments mostly go toward interest only? It takes time before you even start making a dent in your principal.
For this reason, it's important to lock in the right type of mortgage and interest rate for you.
- Fixed-rate mortgages are good if current rates are low, and you're worried they might go up in the future.
- Adjustable-rate mortgages (ARM) are good if you want to secure a low interest rate, to begin with, and then take your chances that they'll stay reasonable, or drop, in the future.
Maybe you're thinking, what's the big deal if the difference is only, say, 2%? But over the life of your loan, that adds up — fast. And, over the course of your lifetime, interest rates might go up and down much more than you think.
This is because, like all goods and services, interest rates fluctuate due to supply and demand. If there are more funds available to borrow and fewer people wanting to borrow, then interest rates will go down.
On the flip side, if there's a shortage of funds and a spike in borrowers, then interest rates will go up. Politics, wars, and disasters can all impact interest rates, just like they influence the cost of gas.
So if you're wondering when to refinance a mortgage, check to see what you'll gain by getting a loan with a different interest rate, or by switching from a fixed rate to an adjustable rate and vice versa.
Personal Factors to Keep in Mind
Before you get in touch with your mortgage lender, all excited to start refinancing, you might like to think about any changes in your life since you got your original loan.
- Credit history. Make sure your credit score is as good as, or better than, it was before. Maybe you've been making all your mortgage payments but missed your car payments a few times. A lower credit score might mean less desirable terms on your new loan.
- Income. If your income has stayed steady or increased, you should be good to go. But if you've suffered redundancy or had to take a pay cut to keep your company in business, you might not get approval as easily.
- Marital Status. If your partner co-signed on your mortgage and you've since split up, this could impact your ability to get a new loan. On the other hand, if you qualified for your mortgage while single and have since got married, you could get better terms this time around.
Ready to Refinance Your Mortgage?
If you're thinking a lower monthly payment, a shorter term, or access to cash sounds great, reach out to a loan officer and see if now is the right time to refinance your mortgage.
Do you have other questions about your mortgage and all the confusing terms related to home loans? Click below to find out more!