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When Should You Refinance a Mortgage Loan?

Rates . Home Value . Credit
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By Karla Lopez

Refinancing a mortgage means you are replacing your existing mortgage or mortgages with a new one that has different, and hopefully, better terms. This new mortgage will pay off your old mortgage loan, and then you become responsible for paying it off. But the question is, when exactly should you do it?

The straightforward answer is whenever you can save money on your current mortgage through refinancing; it’s worth exploring all year-round. Although the old rule of thumb says refinancing is useful if you can get at least one or two percent reduction on the interest rate you’re paying. But, it’s no longer the case now.

Here are the situations when refinancing makes sense.

Mortgage Rates are Going Down

A mortgage is subject to fluctuation because it can be affected by a variety of factors such as market movements, Debt statistics, inflation, U.S. Federal Reserve monetary policy, the economy, and global factors.

Once the mortgage rates nosedive, you’ll be able to save by securing an interest rate that’s lower than what your current loan has. This maneuver is called rate-and-term refinancing wherein you refinance your mortgage for one that usually has the same remaining term but with a lower interest rate.

Again, the traditional rule has it that it’s best to refinance if your rate is one or two percent lower than your existing rate. But in reality, every borrower has different needs and financial goals. A one percent interest rate less may help you save on a $2 million mortgage. However, it’s not going to do much for a $200,000 mortgage.

There are other costs that come with refinancing that are crucial whenever you decide to go its route.

Another situation wherein refinancing can be a good option is when interest rates are anticipated to fall continuously, and you have a fixed-rate mortgage. In such a case, you might consider turning to ARM (Adjustable-Rate Mortgage.)

With an ARM, the interest rate will change over time, typically in relation to an index, which makes it possible for your payments to go up and down. It will make more sense to convert to an ARM if you plan to move in a few years. It owes to the fact that you’re going to forgo the safety of a fixed-rate loan.

Take note also that your ARM will go up too if interest rates increase. Additionally, the initial rate you acquire with an ARM will be effective for a limited period which could range from one month up to five years or more.

The Value of Your Home Increases

Refinancing could be your lifeline if your home’s value has gone up, particularly if you’re still paying off other high-interest debts.

When you refinance, you get to take a new loan that’s bigger than your previous one. You will use this new mortgage to settle the first loan, then you’ll get the difference in cash. This system makes it an excellent alternative to a home equity loan.

For example, you took a $160,000 mortgage five years ago for a house worth $200,000 house. You also put a $40,000 down payment. After a series of regular payments, your debt on a mortgage has now reduced to $100,000. When the property market skyrockets, so do your home whose value now amounts to $250,000.

Since your home is more valuable, you can now refinance for more than $100,000, which is the current balance of your mortgage. If you can refinance for, say, $150,000, you can take home the $50,000 in cash and use it to pay your other debts or other expenditures like home improvement and so on.

It’s vital in every refinancing option to make sure that you will use the money wisely and not get into unsustainable debt. Take heed that it’s part of a loan, so need to repay it and the rest of your mortgage loan.

Further, be sure that you will not end up paying more in mortgage interest than the interest you will pay on any debt.

Your Credit Has Improved

Your credit score is an essential factor in calculating your mortgage rate. Rules have it that you’ll get a lower interest rate if you have a good to excellent credit score.

For instance, if your FICO credit score lies within 660 up to 679 range and you have a 30-year fixed-rate mortgage of $150,000, you’ll pay 3.998% APR as per the myFICO Loan Savings Calculator (interest rate as of August 2019).

With this interest rate, you’ll pay $716 per month and $107,742 for the total interest to be paid for 30 years.

Now if your credit score is playing somewhere between 700 to 759 range, your estimated monthly payment will drop to $683. You could save $12,021 in interest over the life of the loan.

You Have an Adjustable-Rate Mortgage and Mortgage Rates Rise

If you currently have an ARM and If mortgage rates are increasing, you might want to convert to a fixed-rate mortgage or better yet, consider refinancing.

With an ARM, your rate will increase more than what you will pay with a fixed-rate mortgage. If you’re conscious about possible interest rate hikes in the future, converting to a fixed-rate mortgage or turning to refinance can give you some peace of mind.

Takeaway

Refinancing a mortgage will depend on several factors such as the current interest rates, the length of time you plan to live in your home, how long it will take for you to recuperate your closing costs, to name a few. Further, refinancing can be a wise decision if you do it when the situations mentioned above are at your disposal.

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