When you refinance a mortgage, you are paying off one loan and replacing it with a new loan. If you’re thinking of refinancing, begin with asking why you want to refinance? Are you thinking of saving money or solving a bad situation or condition?
There are several reasons to refinance such as replacing an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, tapping into your home’s equity to make repairs or renovations, to buy another home, to consolidate/payoff other high-interest debt such as credit cards. Some homeowners will refinance to shorten the term of their mortgage.
Usually homeowners want to refinance to lower their monthly payment. Before jumping into refinancing, there are numerous considerations to take into account.
The rule of thumb used to be it would be worthwhile to refinance if it would lower your interest rate at least 2%. Some lenders are now saying that number is 1%. If you’re going to be saving 1% on your interest rate, figure out how many years it will take you to recoup the fees that come with refinancing.
Refinancing requires an appraisal, title search and can cost between 3% and 6% of the loan’s principal. It’s critical to determine how much would you really benefit by refinancing. If it costs you $2,500 to refinance, and your monthly payments are reduced by $75.00, it will take you almost three years to see a savings.
When you reduce your interest rate, it generally means you’ll increase the rate that you build equity into your home. Do your research to calculate how much of your payment will be going towards your principal. When you first get your loan, most of your payment will go toward the interest. The longer you have your loan, the more your payment will go toward the principal. Remember, when you refinance, you’ll start all over again, with most of your payment going toward the interest.
You’ll also need to decide what type of loan will best suit your needs. If you want to convert to an ARM, you’re taking a chance whether the interest rates will rise or fall in the future. ARMs usually offer lower introductory rates. In an environment where the interest rates are falling and you don’t plan on staying in your home for more than 3-5 years, converting to an ARM may allow you to reduce both your loan’s interest rate and monthly payment.
With a fixed-rate loan, your mortgage interest rate will remain the same during the life of the loan. There are 10-year, 15-year and 30-year fixed rate loans you can choose from. Fixed-rate loans let the borrower budget and predict their future payments without worrying about a change in interest rates, especially when the rates are rising.
A qualified real estate attorney can look at the terms of your loan and discuss whether whether it is the right choice for you to refinance, and discuss any available alternatives.
There are also tax advantages and consequences that you may want to discuss with a tax attorney as part of your research on whether to refinance. If you decide to refinance, you may also want to consider the pros and cons of placing your home in a Trust.