Up in the air about refinancing your mortgage?
That's okay. Refinancing, which is essentially the process of paying off your existing mortgage with a new one, isn't the right option for everyone. And for this reason, it's important to weigh out the pros and cons.
By doing so, you can determine if you'll actually benefit from refinancing.
For example, you could be lowering your interest rate by 25 percent, but if that comes with thousands of dollars in closing costs, it could take a long time to break even, says Shashank Shekhar, a loan originator with Arcus Lending in San Jose, California.
Not an easy decision is it? To help, we've hashed out the pluses and minuses of refinancing to see if it makes sense for you and your financial situation.
Of course, you'll need to first qualify for the lower rate, but if you do - you could be saving a lot of money. In fact, even an interest rate that's a half percent less could garner a good chunk of savings.
Just consider this example from the Federal Reserve, which compares the monthly payments on a 30-year fixed-rate loan of $200,000 at 5.5 and 6 percent interest.
Now, imagine the savings if you could lower your interest rate by 1 or 2 percent...
"It is not unusual to pay 3 percent to 6 percent of your outstanding principal in refinancing fees," according to the Federal Reserve, which adds that fees could include an application fee, loan origination fee, an appraisal fee, and more. "These expenses are in addition to any prepayment penalties or other costs for paying off any mortgages you might have."
A prepayment penalty, in case you're wondering "is a fee that lenders might charge if you pay off your mortgage loan early, including for refinancing," according to the Federal Reserve.
So, before you refinance, you'll want to do some research and make sure that the refinancing savings will outweigh any and all fees.
For starters, shorter-term mortgages - like a 15-year mortgage versus a 30-year mortgage - generally has lower interest rates, according to the Federal Reserve.
What's more, the shorter your mortgage term, the sooner you'll be out of debt and the less interest you'll have to pay in the long run.
For example, the Federal Reserve says to compare the total interest costs for a fixed-rate loan of $200,000 at 6 percent for 30 years with a fixed-rate loan at 5.5 percent for 15 years.
While the total interest savings are indeed significant, "The trade-off is that your monthly payments usually are higher because you are paying more of the principal each month," says the Federal Reserve.
Why? Because if you move soon after you refinance, "The monthly savings gained from lower monthly payments may not exceed the costs of refinancing," the Federal Reserve says.
If you will be moving - and you still want to refinance - the Federal Reserve suggests using a break-even calculation, which could help you figure out whether it's a smart decision.
Unfortunately, sudden changes like job relocation or a divorce may be out of your hands.
But if you do sense that the future in your home is a bit unstable, you may want to hold off on refinancing.
And if you currently have an ARM, now is a great time to refinance to an FRM.
In fact, with rates at historic lows, an average of 3.39 percent on a 30-year fixed-rate mortgage as of November 1, according to federal lender, Freddie Mac, there may not be a better time to refinance.
"Given the uncertainty in the real estate market and the historical low rates on offer now, I always advise my clients to go with a FRM wherever possible," explains Shekhar.
So, to avoid any uncertainty with your mortgage payments, you may want to refinance and lock in today's record-low rates.
If you're still unsure, then consider this: If you stick with an ARM and rates go up in the next few years, will you be in utter regret?
If so, refinancing may not be in your best interest, especially since a bad credit score often means having a higher rate when you refinance, explains Shekhar.
"For every 20 point drop in credit from 740, you pay higher in closing cost, interest rate, or both," says Shekhar. "In some cases, your closing cost can increase by 2 percent or more."
As you can see, a bad credit score could definitely work against you during the refinancing process.
So, before you refinance, it might be a good idea to try and improve your score by paying credit card bills on time and keeping balances low on your credit cards, according to myFICO, the consumer division of the Fair Isaac Corporation, which provides a global standard for measuring credit risk.
That's okay. Refinancing, which is essentially the process of paying off your existing mortgage with a new one, isn't the right option for everyone. And for this reason, it's important to weigh out the pros and cons.
By doing so, you can determine if you'll actually benefit from refinancing.
For example, you could be lowering your interest rate by 25 percent, but if that comes with thousands of dollars in closing costs, it could take a long time to break even, says Shashank Shekhar, a loan originator with Arcus Lending in San Jose, California.
Not an easy decision is it? To help, we've hashed out the pluses and minuses of refinancing to see if it makes sense for you and your financial situation.
Pro #1: You Could Score a Lower Interest Rate
This is perhaps the biggest pro of refinancing your mortgage: a lower interest rate.Of course, you'll need to first qualify for the lower rate, but if you do - you could be saving a lot of money. In fact, even an interest rate that's a half percent less could garner a good chunk of savings.
Just consider this example from the Federal Reserve, which compares the monthly payments on a 30-year fixed-rate loan of $200,000 at 5.5 and 6 percent interest.
| Monthly payment @ 6 percent: | $1,199 |
|---|---|
| Monthly payment @ 5.5 percent: | $1,136 |
| The difference each month is: | $63 |
| Over 10 years, you will save: | $7,560 |
Con #1: Refinancing fees
Getting a lower interest rate sounds great, right? Of course it does. But like most things in life, there are costs that come with refinancing - and these costs could really add up."It is not unusual to pay 3 percent to 6 percent of your outstanding principal in refinancing fees," according to the Federal Reserve, which adds that fees could include an application fee, loan origination fee, an appraisal fee, and more. "These expenses are in addition to any prepayment penalties or other costs for paying off any mortgages you might have."
A prepayment penalty, in case you're wondering "is a fee that lenders might charge if you pay off your mortgage loan early, including for refinancing," according to the Federal Reserve.
So, before you refinance, you'll want to do some research and make sure that the refinancing savings will outweigh any and all fees.
Pro #2: You Can Shorten the Length of Your Mortgage
What exactly is the benefit of refinancing to a shorter term mortgage, you ask?For starters, shorter-term mortgages - like a 15-year mortgage versus a 30-year mortgage - generally has lower interest rates, according to the Federal Reserve.
What's more, the shorter your mortgage term, the sooner you'll be out of debt and the less interest you'll have to pay in the long run.
For example, the Federal Reserve says to compare the total interest costs for a fixed-rate loan of $200,000 at 6 percent for 30 years with a fixed-rate loan at 5.5 percent for 15 years.
| Monthly payment | Total interest | |
|---|---|---|
| 30-year loan @ 6 percent | $1,199 | $231,640 |
| 15-year loan @ 5 percent | $1,634 | $94,120 |
Con #2: If You Move Out of Your Home Soon, Refinancing Could Cost You
Planning to move out of your home in the next few years? If so, it may not be the right time to refinance.Why? Because if you move soon after you refinance, "The monthly savings gained from lower monthly payments may not exceed the costs of refinancing," the Federal Reserve says.
If you will be moving - and you still want to refinance - the Federal Reserve suggests using a break-even calculation, which could help you figure out whether it's a smart decision.
Unfortunately, sudden changes like job relocation or a divorce may be out of your hands.
But if you do sense that the future in your home is a bit unstable, you may want to hold off on refinancing.
Pro #3: You Could Switch to a Fixed Rate Mortgage (FRM)
Cheat sheet: an interest rate on a fixed-rate mortgage (FRM) remains the same for the life of the loan, while an interest rate on an adjustable-rate mortgage (ARM) adjusts periodically based on an index.And if you currently have an ARM, now is a great time to refinance to an FRM.
In fact, with rates at historic lows, an average of 3.39 percent on a 30-year fixed-rate mortgage as of November 1, according to federal lender, Freddie Mac, there may not be a better time to refinance.
"Given the uncertainty in the real estate market and the historical low rates on offer now, I always advise my clients to go with a FRM wherever possible," explains Shekhar.
So, to avoid any uncertainty with your mortgage payments, you may want to refinance and lock in today's record-low rates.
If you're still unsure, then consider this: If you stick with an ARM and rates go up in the next few years, will you be in utter regret?
Con #3: If Your Credit Score is Bad, Refinancing May Yield a Higher Rate
Have you struggled to make your last few credit card payments? Has your credit score suffered as a result?If so, refinancing may not be in your best interest, especially since a bad credit score often means having a higher rate when you refinance, explains Shekhar.
"For every 20 point drop in credit from 740, you pay higher in closing cost, interest rate, or both," says Shekhar. "In some cases, your closing cost can increase by 2 percent or more."
As you can see, a bad credit score could definitely work against you during the refinancing process.
So, before you refinance, it might be a good idea to try and improve your score by paying credit card bills on time and keeping balances low on your credit cards, according to myFICO, the consumer division of the Fair Isaac Corporation, which provides a global standard for measuring credit risk.
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