Refinancing your home loan can be a great financial decision if it reduces your mortgage payment, shortens the term of your loan, or helps you build up more capital. It can free up money in your monthly budget, lower the overall cost of the loan, and even provide you with cash from your home equity for bills or renovations. With mortgage rates near their lowest point, it's a good time to consider refinancing. To determine if it's the right time to refinance, consider how long you plan to stay in your home, your financial goals, and your credit score.
All of these things, along with current refinance interest rates, should influence your decision. The current average mortgage rate for a 30-year fixed-rate loan is 6.92%, according to Freddie Mac. Refinancing is probably worth considering if you can lower your current interest rate by at least 0.5%. If you want to pay off the loan faster with a shorter term, have raised enough capital in your home to refinance without mortgage insurance, or want to take advantage of a portion of your home's net worth by refinancing with cash out, then refinancing may be a good option. When the Federal Reserve lowers short-term interest rates, many people expect mortgage rates to keep up. However, mortgage rates don't always go hand in hand with short-term rates.
Avoid focusing too much on a low mortgage rate that you read about or see advertised. Mortgage refinance rates change during the day, every day and the rate quoted to you may be higher or lower than the published rate at any given time. Your mortgage refinance rate is based primarily on your credit score and the equity you have in your home. You're more likely to get a competitive rate as long as your credit score is good and you have proof of stable income. An oft-cited rule of thumb says that if mortgage rates are lower than the current rate by 1% or more, it might be a good idea to refinance.
But that's traditional thinking; a half-point improvement in your rate might even make sense. To determine if refinancing makes financial sense for you, it's a good idea to calculate the real numbers with a mortgage refinance calculator. To calculate your potential savings, you'll need to add up the costs of refinancing such as an appraisal, a credit check, opening fees, and closing costs. Also check if you're facing a penalty for paying off your current loan early. Then when you figure out the interest rate at which you could qualify for a new loan, you can calculate your new monthly payment and see how much, if any, you save each month. You'll also want to consider if you have at least 20% equity; the difference between your market value and what you owe on your home.
Check the values of properties in your neighborhood to determine how much your home could be valued for now or consult a local realtor. Home equity is important because lenders usually require mortgage insurance if you have less than 20% of equity; this protects your financial interests in the event of default. Mortgage insurance isn't cheap and is included in your monthly payment so be sure to include it in your calculations of potential refinancing savings. Once you have a good idea of the costs of refinancing, compare your “global” monthly payment to what you currently pay. Think about whether your current home will fit your lifestyle in the future; if you're close to starting a family or having an empty nest and you're refinancing now there's a chance you won't stay at home long enough to pay the expenses. Homeowners who have already paid a significant amount of capital should also think carefully before embarking on refinancing.
If you've been on your loan for 10 or more years, refinancing to a new loan for 30 or even 20 years even if it significantly lowers your interest rate significantly reduces interest costs because interest payments are paid in advance; the longer you've been paying your mortgage, the more of each payment will go to principal rather than interest. Ask your lender to calculate the term numbers of a loan equal to the number of years you have left on your current mortgage. You can lower your mortgage rate, lower your payments and save a lot of interest if you don't extend the term of your loan. Make predictions about how long you'll stay in your current home and then think about the details of your current mortgage; how these factors are combined with each other could influence your refinancing decision. Let's say you bought a home with an adjustable rate mortgage for an initial five-year term about 3%. You plan to stay here for several more years; if the time approaches when the adjustable rate can reset and rise then it may be beneficial to refinance into a fixed-rate mortgage to get an interest rate that doesn't fluctuate.