The Federal Reserve is doing homeowners a big favor, keeping interest rates low. That means you should consider refinancing your old higher-rate mortgage. But how do you go about refinancing your old mortgage and how will you know it makes sense?
First, you should know that not everyone can qualify for a new mortgage. If some of your payments were delinquent or your home is underwater, for instance, you may have a problem. And, not everyone should refinance. Before you rush out to meet with your banker, be sure it makes economic sense for you.
Let’s consider some factors that might affect your decision:
Assess Your Situation
The first thing you need to do is to review your existing mortgage and write down the interest rate, current payment, loan balance and type of loan. That gives you a basis for comparison. Don’t expect every loan officer to point you in the right direction. Keep in mind they are paid to make loans and often don’t know enough about your situation to determine the appropriateness of refinancing.
Interest Rate Difference
One of the main factors to consider when refinancing is the interest rate differential between your existing mortgage and what is available in the market place. The accepted rule of thumb is to consider a refinance if the new rate is at least 1% less than the current rate. However, watch out for closing costs – sometimes as much as 2% of the loan. Knowing the right questions to ask can ultimately help you avoid this blindspot.
Adjustable Versus Fixed Rate
If you bought your house with an adjustable rate mortgage (ARM), then you also want to know the specifics of when the interest rate increases and by how much it can go up each year. Homeowners with ARMs need to make sure they can afford the future payment in the event of a rate increase.
With interest rates at historic lows, it makes sense for homeowners with adjustable rate mortgages to seriously consider a fixed rate. An adjustable mortgage rate is typically cheaper than a fixed, but there is good reason for the preferred pricing. On the other hand, the spread between fixed and adjustable mortgages have narrowed in recent months. In late July of 2019, a 30-year fixed loan was about 3.875% and a 5/1 ARM was about 3.7%.
The 5/1 means the rate says the same for five years, and then shifts according to whatever benchmark the lender uses. Let’s say rates shoot up five percentage points. Wouldn’t you rather lock in at 3.875% than end up paying 8.7%?
How Long You’ll Live There
How long you plan to stay in your home is another major factor. You need to know how many years it will take to recoup the cost of the refinance. For instance, it makes no sense to refinance if you plan to move in three years if it takes four years to recoup the costs of refinancing.
Other Uses for Mortgage Money
Along with lowering your interest rate, it could be prudent to use the equity in your home to pay off high interest credit cards, remodel your house or purchase an investment property. A word of caution: be sure that your financial planning includes how best to use savings productively. You don’t want to accumulate unnecessary debt for the sake of refinancing.
Shopping for a Loan
With the ever-changing rules and regulations in the mortgage industry, be circumspect when shopping for a lender and consider evaluating more than one provider. Look for institutions that pride themselves on customer service and working in your best interest. Let them know you will comparing their offering and discussing it with your financial advisor (if you have one).
Talking to Your Financial Adviser
If you are like most, your home is your largest liability and largest asset. As such, reviewing the efficiency of refinancing can greatly impact the long-term success of your financial plan. The idea of refinancing can seem like “a no-brainer”. However, careful consideration and comprehensive planning can greatly reduce the risk of making an irrevocable mistake.
If you need help assistance with refinancing, or other financially challenging elements, talk with your adviser. If you don’t have an adviser, or simply want a second opinion, our team of professionals can help. If you are ready to talk, visit our website to request a conversation.