You hear that everyone is refinancing, so you think you should jump on the bandwagon. Rates are low right now, so why not, right? While it might seem like a good idea, there are some things you should consider before you jump in headfirst.
It Will Cost You Money
As much as you are probably refinancing your loan to save money, it will cost you money to do that. Just like you paid closing costs when you bought your home, you will pay them again when you refinance. Does it make sense to pay money to save money? Sometimes it does make sense, but not always.
It comes down to your break-even point. This is the point that your savings cover the closing costs and you are then able to enjoy the savings of the new loan. Just how long is too long for a break-even point? It depends on your situation, but the average borrower has a 3-year break-even point.
You can figure out your break-even point by dividing the total closing costs by the monthly savings. For example, if your closing costs are $4,000 and you’ll save $75 per month with the new loan, your break-even point is:
$4,000/$75 = 53.3 or 54 months
If you think you will still be in the home long after 54 months have passed, you may do well with the refinance. On the other hand, if you know you’ll move in the next 3 years; it doesn’t make sense to pay to refinance.
You Might Have a Lower Loan-to-Value Ratio
If you’ve made your mortgage payments on time and your home appreciated over time, you might find that you have a lower LTV this time around. This could work to your favor. Are you paying PMI now? You might be able to eliminate it if your LTV is below 80%.
A lower LTV may also help you get an even better interest rate. If rates are lower now than they were when you bought your home, you are already in good hands. But if you have a lower LTV too, you prove to the lender that you are a lower risk now, which could work in your favor.
Think Long and Hard Before Using Your Equity
When you refinance, you may have the option to tap into your home’s equity. If you owe less than 80% of the home’s value, the lender may let you borrow up to 80%. Just because you can doesn’t mean you should, though.
Before you take equity out of your home, figure out why you are doing so. Are you trying to consolidate debt? Are you paying for a large purchase or event, such as college or a wedding? Are you taking the funds to use as an emergency fund? You need to think long and hard about why you want the money. You should also consider if there are other ways you can get the money you need, while leaving your home’s equity alone.
Unless you are using the money to reinvest in your home, such as with home remodeling or major repairs, it’s best to leave the money where it is. You’ll appreciate the notion when you own the home free and clear and are able to take the entire profit in your pocket rather than paying off your old debts.
You Might Reset Your Term
Finally, pay close attention to the new term of your loan. Are you taking the same term you had originally? How long has it been since you’ve taken out the original loan? If you’ve paid on your loan for several years already, you may not want to start back at square one. Instead, you might want to take a shorter term that allows you to keep making progress on your debt rather than adding years back onto it.
Before you refinance your home, think long and hard about your objective in doing so. Are you trying to save money? Do you need to tap into your home’s equity? Are you trying to eliminate PMI? Keep this goal in mind as you figure out which loan will work the best for you.