Many people think that when rates drop they should jump on the refinance bandwagon and get that lower rate. For some people this might be the right option, but likely to be for a select few. A lower rate is not the only thing you need to look at – there are many factors to consider before you trade in your own mortgage for a new one with a lower rate.
How Long Have you had the Mortgage?
The most important factor is how long you have already had your first mortgage. Did you just get it a year or two ago or have you been paying on it for 10 years? These are just random numbers being thrown around, but what you need to look at is how much interest you already paid on the home. The first few years are mostly interest charges you pay month after month. As the years pass, however, you start to hit more of the principal of the loan. This means you pay less interest and more principal. If you refinance, say after 10 years, and go back to a 30-year loan, you are starting from scratch again, which means paying hefty amounts of interest and not touching the principal at all. This could be a backward move for you depending on your situation, forcing you to have mortgage payments for many more years as you age.
Are you Staying in the Home?
If you plan to stay in your home for the foreseeable future, refinancing might not make sense because again, you start all over again, meaning your term resets at 30 years and you are back to paying mostly interest rather than hitting the principal amount of the loan. On the other hand, if you are going to move in the near future and the interest rate is low enough to save significant money, then it may be worth refinancing so you can save money over the short-term. Yes, you will still be back to paying mostly interest, but if you are not staying in the home, you will get the principal amount back when you sell the home, and if the interest costs are lower, you will have more money in your pocket.
Can you Afford a Shorter Term?
One of the best ways to take advantage of lower interest rates is to lower your term if you have had your mortgage for a while. For example, if you have a 30-year term, but have paid on it for 7 years, you have 23 years left. If you were to refinance back into another 30-year mortgage, you lose those 7 years. On the other hand, if you refinance your original 30-year mortgage into a 20 or 15-year mortgage, you can take advantage of the rates and not start from scratch again. Even though you will pay most interest up front, it will not be for long because a shorter term means you pay more principal each month so that the loan gets paid off in time.
Figure out the Costs
Even if you have only held your 30-year mortgage for a year or so, make sure to figure in the costs of refinancing into another loan. Every lender charges different costs for a new loan. If the closing costs are exceptionally high, it might not make sense to lower the interest rate and pay the costs. If the costs are not high and the interest rate is low enough to save you a significant amount of money it might make sense to refinance. If you find one lender’s costs are exceptionally high, you can always shop around to see if lower costs are available.
As you can see, there is no right or wrong answer regarding whether or not you should refinance your 30-year loan. It depends on your exact circumstances. In general, if you refinance into a shorter term, I almost always makes sense to refinance. If you are keeping the 30-year term, you need to crunch the numbers to determine how many years you will add onto your payments; how much you can afford; and how much the overall refinance will cost you in order to determine what is right.
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.