Personal Finance 101: Is it Time to Refinance Your Mortgage?
By Brittany Mollica
Mortgage rates have been at historically low levels this year – one of the few genuinely good things to happen in 2020. If you haven’t yet looked into refinancing your mortgage, you may be missing out.
However, refinancing solely to get a lower interest rate isn’t always the smartest financial move, so here are some questions to consider before you call up a mortgage broker:
What is your primary goal for refinancing?
It’s important to understand your broader goals, because refinancing can help you modify your cash flow in different ways. Two common goals:
Lower your monthly expenses – if cash flow is tight, you may be able to reduce your total expenses through a refinance. By getting a lower interest rate or lengthening the term of the loan (or both), you can get more free cash each month to put toward your other financial goals.
Pay off your mortgage more quickly – if your goal is to reduce your total long-term payments, you can shorten your mortgage term while refinancing, which often will get you an even better interest rate. However a shorter term may increase your monthly payment, so it’s important to understand whether you can afford the new payment.
How long will it take you to break even after paying the refinance costs?
Refinancing can be expensive – closing costs may include items such as appraisal fees, inspection fees, application fees and mortgage insurance fees. So you’ll want to weigh these costs against the benefit of a lower interest rate. You need to ask some questions first:
· What is the cost to refinance?
· What is your current mortgage rate?
· How long do you plan to be in your home?
The answers to these questions can help you calculate the break-even point for refinancing - the point in time where you’re financially better off for having refinanced. If you are likely to move within a few years, refinancing may not be worth the cost and effort.
One rule of thumb: the more you can reduce your interest rate, the sooner you will break even.
Do you have other debt that you’re looking to consolidate?
If you have higher-interest debt (credit card, home equity loan, student loan, etc.) and you have equity in your home, you may want to refinance to consolidate debt. You will ideally end up with a simpler and lower total monthly debt payment, because you’re making payments to only one institution and your mortgage rate is likely to be lower than any other debt. Keep in mind that this would likely extend the amount of time it takes to pay off the debt, so you should discuss the details of consolidating with your financial advisor.
Do you currently have an adjustable-rate mortgage or a fixed-rate mortgage?
If you currently have a fixed-rate mortgage but don’t plan to live in your current home forever, it could be a smart choice to refinance to an adjustable-rate mortgage (ARM). An ARM offers a lower rate for an initial period of time, say 5 or 7 years, after which it becomes a variable rate (and your rate will increase if interest rates are higher). ARMs work best if you’re planning to sell your home before the rate changes or if you think mortgage rates are likely stable or declining. However, be cautious because your plans might change; you may end up paying a higher rate if you live there longer than you intended.
Alternatively, if you currently have an ARM that is past the fixed-rate period, you may want to refinance to lock into today’s low fixed rate. Having a fixed payment can be especially useful for budgeting and cash-flow planning, as it makes your future expenses more predictable.
How is your credit score?
The higher your credit score, the better an interest rate you're likely to qualify for. If you don’t regularly check your credit report (you can do this for free once every 12 months), now may be a good time to see where you stand. And if your credit report is not as great as you hoped, there’s no better time to start improving it.
There are many factors to consider when deciding whether to refinance your mortgage, but now could be a great time to take advantage of low interest rates. Your financial advisor can help you determine your break-even point, your long-term implications of refinancing, and whether refinancing aligns with your financial goals. Let us know if we can help!
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