Refinancing may sound like a good idea when mortgage rates decrease. It’s a chance to get a better loan and a cheaper rate. Many banks encourage refinancing, but getting a new mortgage doesn’t make sense financially for everyone.
So, before you jump on the bandwagon and apply for a new mortgage to replace your existing one, here are four questions to ask yourself.
1. Why do I want to refinance?
For refinancing to make sense, you need to clearly understand your reasons for refinancing. For example, do you want to lower your mortgage rate? Are you looking to borrow cash from your equity? Do you need to convert your adjustable-rate mortgage to a fixed-rate?
When you know the reasons for refinancing, you’re able to prepare for the process, educate yourself, plus you’ll know what to expect going forward. There are numerous mortgage options, and if you don’t understand your reasons for refinancing, you might get stuck with a mortgage loan that doesn’t meet your needs.
2. Where am I in life?
Refinancing may not make sense if you’re close to paying off your present mortgage, and if you’re close to retirement. Many people refinance into another 30-year term, which is perfectly okay — but you need to consider where you are in life.
If you’re only a few years into your original mortgage, and retirement is many years off in the future, stretching your term another 30 years isn’t a huge deal. You might still be able to pay off the mortgage before retiring. But if you’re near retirement age, or if you’ve already put 20 or more years into paying off your home, refinancing might not be the wisest move — regardless of low interest rates.
Since your income will likely drop after retiring, you’re better off sticking with your original mortgage. You can possibly pay off the home before leaving the workforce, or soon thereafter, and live your retirement years mortgage-free.
3. What does a no-cost refi mean?
Several lenders advertise no-cost refinancing, which is attractive because you don’t have to pay out-of-pocket cash at closing. Just know that there’s no such thing as a “true no-cost refinancing.”
There are fees with any type of mortgage, and lenders will get their money one way or another. You may not write a check at closing, but the lender may include the closing costs in your mortgage, or they’ll charge a higher interest rate to compensate for no out-of-pocket costs. Either way, you end up paying something.
4. Is the savings worth the cost?
When refinancing, closing costs range between 2% and 5% of the mortgage balance. Therefore, you need to count the cost and determine whether refinancing is worth the closing fees.
To illustrate, if the closing costs are $5,000, and refinancing reduces your mortgage payment by $100, it’ll take approximately 50 months (or more than four years) to break even. In order for refinancing to make sense from a financial standpoint, you’ll need to live in the home for at least another four years. If you plan to move within the next 2 to 3 years, refinancing doesn’t work because you won’t recoup what you spent in closing.
Refinancing can be financially beneficial — but only when it makes sense. Whether you need a lower interest rate or you’re looking to convert your ARM to a fixed-rate, weigh the pros and cons and don’t make a hasty decision.