Should I Refinance – The Oft-Wondered Question And The Truth About Refinancing Your Mortgage

Even when mortgage rates are low and friends and colleagues are bragging about who got the greatest deal, refinancing isn’t always the wisest option. This is because refinancing a mortgage can take a long time, be costly at closing, and require the lender to pull your credit score.

What is refinancing?

When you refinance your mortgage, you’re getting a new loan to replace your old one. The new loan may have different terms, such as switching from a 30-year to a 15-year period or from an adjustable to a fixed rate, but the most common difference is a reduced interest rate. Refinancing your mortgage can help you lower your monthly payment, save money on interest throughout the life of your loan, pay off your mortgage faster, and access the equity in your house if you need money for any reason.

How does refinancing a mortgage work?

Refinancing will feel comparable like applying for a mortgage for the first time. A lender will look through your finances to establish your risk level and whether you qualify for the best interest rate. It’s a brand-new loan, and it could come from a different lender than the one you used to purchase your property.

You might be resetting the repayment clock with this new loan. Assume you’ve paid on your current 30-year mortgage for five years. That means the loan will be paid off in 25 years. If you refinance to a new 30-year loan, you’ll have to start afresh and return it in 30 years. You’ll pay off your debt five years sooner if you refinance to a new 20-year loan.

Closing expenses are associated with refinancing, which might influence whether or not having a new mortgage makes financial sense for you. These expenses can range from 2 percent and 5 percent of the amount you refinance.

How to refinance a mortgage

Here’s a step-by-step guide for the work involved.

1. Do the math and prepare
2. Shop around for mortgage lenders
3. Compare rate quotes and loan terms
4. Apply
5. Lock in your interest rate
6. Have your home appraised
7. Close on the loan

Why should you refinance

Refinancing requires some work, so is it really worth the extra paperwork and additional costs? There are some great reasons to invest the time and money in a refinance:

• You can get a lower interest rate.
• You can get a different kind of loan.
• You can use your equity to borrow more money.
• You can shorten your loan.

Pros and cons of refinancing a mortgage

The current low-interest market has made refinancing a popular move for many homeowners. However, it’s not all upside. If you’re thinking about refinancing, make a list of the advantages and disadvantages to see if it’s right for you. Depending on what type of mortgage you’re paying off and what type you’re refinancing into, the benefits of refinancing your mortgage might include the following:

Pros

• You could lower your interest rate.
• You could lower your mortgage payment and create more space in your monthly budget.
• You could decrease the term of your loan and pay it off sooner.
• You could tap into your home’s equity and take cash out at closing.
• You could consolidate debt — some homeowners use refinancing to put student loans or other debts into one simple payment.
• You could change from an adjustable-rate to a fixed-rate mortgage, or vice versa.
• You could cancel private mortgage insurance premiums to avoid paying unnecessary fees.

Cons

• You’ll have to pay expensive closing costs.
• You might have a longer loan term, adding to your costs and delaying your payoff date.
• You could have less equity in your home if you take cash out.
• You might need to deal with borrower’s remorse if rates drop substantially after you close.
• It’s not an overnight activity: The refinancing process can take between 15 and 45 days or more.
• Your credit score will temporarily take a hit.
• Spend time shopping for a new mortgage and submitting required paperwork

Types of mortgage refinancing

• Rate-and-term refinance

This is the most basic type of refinancing, in which the loan’s interest rate, term, or both are changed. This can help you save money on interest or lower your monthly payment. Unless you incorporate some closing expenses into the new loan, the amount you owe won’t change.

• Cash-out refinance

When you choose a cash-out refinance, you’re taking money out of your home to spend. This raises your mortgage debt while also providing you with money to invest or put toward a goal, such as a home renovation project. During a cash-out refinance, you can also lock in a new term and interest rate.

• Debt-consolidation refinance

Obligations-consolidation refinances are similar to cash-out refinances in that they provide cash, but the distinction is that you utilize the cash from the equity you’ve built in your house to pay off other non-mortgage debt, such as credit card debt. Your mortgage debt will grow, but because mortgage rates are often lower than other types of debt, you will save money in the long run (plus, you might be able to take advantage of the mortgage interest deduction). On a credit card, for example, you’re probably better off paying a fixed 3.5 percent interest rate rather than a variable 15 percent interest rate.

• Streamline refinance

Borrowers benefit from a streamline refinance since it eliminates some of the requirements of a traditional refinance, such as a credit check or appraisal. FHA, VA, USDA, and Fannie Mae and Freddie Mac loans all qualify for this option.

Rule of thumb: When should you refinance your mortgage?

If you have a mortgage, there is a simple guideline that might help you determine when it is time to refinance. Refinancing can save you money or lose you money.

When interest rates are low, homeowners are frequently encouraged to refinance their mortgages. Many mortgage advertising, in fact, advise refinancing to save money by taking advantage of historically low rates. The general guideline is that refinancing is best done when interest rates are at least 1% lower than your present rate.

However, that isn’t the only aspect to consider. We’ll go through the advantages and disadvantages of the 1% rule of thumb for refinancing, as well as present some instances and discuss another mortgage rule of thumb to help you assess your alternatives.

How does the refinancing rule of thumb work?

When you can acquire an interest rate that is at least one percentage point lower than your current rate, you should consider refinancing your house, according to the 1 percent refinancing rule of thumb. The new rate should be as low as possible.

“If you have a $500,000 loan, a [1 percentage point] reduction in rate saves you around $280 per month, or $3,360 per year,” Melissa Cohn, executive mortgage banker at William Raveis Mortgage, told The Balance via email.

Why the 1% rule for refinancing generally works

It makes sense to use 1% as a rule of thumb when considering when to refinance because you might save thousands of dollars each year. “If you have a conforming loan, presuming closing fees are roughly $6,000,” Cohn said, “then it [will take] just under two years to break even and actually take advantage of the savings with the refinancing.”

Some homeowners become thrilled about the possibility of refinancing when interest rates drop even a little. However, if the rate is less than one percentage point lower than your existing rate, your savings will be minimal.

Let’s imagine you want to refinance a $200,000 loan with a 6.0 percent interest rate and a $1,199 monthly payment. Here’s how much you’d save if you refinance to lower rates by 0.5 or 1 percentage point.

However, not all of your savings will end up in your wallet. You’d have to deduct refinancing fees, closing charges, and prepayment penalties from the total. According to Freddie Mac, closing expenses average around $5,000. When you consider these costs, the potential savings of refinancing at a rate less than one percentage point lower than your current rate may not be worth it.

1% refinancing rule vs. break-even point rule

The 1% refinancing rule of thumb is a decent starting point, however it should be compared to the break-even point rule of thumb. “Predicated on closing costs and savings, this rule of thumb is based on how long it will take you to break even on the refinancing,” Cohn added. After you’ve paid off your refinancing fees, this is when you’ll actually start saving money. As a result, as part of your refinancing decision, you should think about how long you plan to stay in the house.

Let’s return to our previous example of refinancing a $200,000 mortgage from a 6% to a 5% interest rate. You’d save $125 every month after taxes, or $90 total. However, let’s say your new mortgage fees and closing charges total $2,500. If you split your spending ($2,500) by the monthly savings ($91), it will take you 28 months to break even. If you don’t plan on staying in the house for a long time, refinancing your mortgage may not be worth it.

When a homeowner refinances their mortgage, they take out a new loan to pay off—and replace—their old one. Borrowers can use a mortgage refinance calculator to determine their new monthly mortgage payments, total refinance expenditures, and the time it will take to repay those costs.

Estimate your monthly payments with a mortgage calculator

While you may find many mortgage calculators on one click, forbes.com  provides one of the most authentic and reliable mortgage calculators. You just have to visit their website https://www.forbes.com/advisor/mortgages/mortgage-refinance-calculator/

The mortgage refinance calculator on Forbes Advisor allows you to calculate your new monthly mortgage payment based on the terms of your current and refinanced loans. It also calculates how much you’ll save in monthly payments and interest throughout the life of the loan using that information. You may use the calculator to figure out how much it will cost to refinance and how long it will take to recoup those expenditures (your break-even point).

To make these calculations, Forbes’ tool evaluates this data:

• Information about the current loan. The mortgage refinance calculator’s initial section requires you to enter current information such as your monthly payment, loan interest rate, and remaining balance and term.
• New loan terms have been established. Calculate your new mortgage payment based on a new interest rate and loan duration in this portion of the calculator. To establish a target payment that works for you, experiment with interest rates and loan terms.
• A mortgage point is prepaid interest that is equivalent to 1% of the remaining mortgage debt (or new loan value). The upfront cost of refinancing a mortgage with this form of payment is higher, but each point reduces your interest rate by 0.25 percent.
• Fees for refinancing. The calculator’s final section totals the refinancing charges, which include application fees, a credit check, title search and insurance, document preparation, and municipal fees.

Find the best rates for refinancing your mortgage

Because the costs of refinancing a mortgage can quickly pile up, it’s critical to shop around for the best interest rates and fees. Start by looking at your existing lender for the best refinancing conditions. Similarly, if you already have a relationship with another bank, you may probably shorten the application process and get better conditions.

Nationally chartered or community banks are usually the best locations to start when seeking a conventional mortgage. Shop around at a range of large banks, local banks and credit unions to ensure you obtain the best terms for your needs and credit history. Also keep in mind that if you want to refinance rapidly, you may want to choose an alternate lender, like an online non-bank company—although this normally comes with a higher interest rate.

Before applying for a refinancing loan, consider the following factors:

• Credit score
• Home equity
• Availability of cash to lower your interest rate
• Employment status
• Debt-to-income ratio

When should I refinance my car loan?

Here are some things to consider if you’ve recently been offered to refinance your automobile or simply want to learn how to refinance a car loan.

The optimum time to refinance your auto loan is when it will save you money in the long run, but it may also be beneficial if you want to lower your monthly payments. Here are a few scenarios where refinancing makes sense:

• The cost of refinancing an automobile loan has decreased: The prime rate and other factors influence the interest rates on most auto loans. If you bought your automobile a long time ago, car loan rates may have fallen since then.
• Even if market rates haven’t changed, boosting your credit score may be enough to secure a reduced rate. The better your credit score, the better loan terms you’ll get. If your credit score has improved after you took out your first loan, you may be eligible for better terms.
• Dealers typically demand higher rates than banks and credit unions, so you acquired your first loan from them. If you took out your first loan through a dealer, refinancing directly with a lender may result in a lower rate.
• You need lower monthly payments: Refinancing a car loan, with or without a lower interest rate, may be your ticket to a more affordable payment. You could refinance your loan to a longer term if your budget is tight and you need to lower your auto payment (from 36 months to 48 months, for instance). However, keep in mind that while you may pay less per month with this technique, you will pay more over the course of the longer loan.

Tips to follow when refinancing your car loan

Timing isn’t the only factor to consider when it comes to refinancing your auto loan. Below are some tips to follow when it is time to refinance.

1. Shop around

Shop around and compare interest rates and terms from multiple lenders before applying with one. Because each lender has their unique formula for calculating your rate, getting multiple quotes is critical. You may be able to get prequalified before submitting an application and obtain a rate estimate with only a soft credit inquiry, which will have no effect on your credit score.

If there isn’t a pre-qualification tool available, keep your applications as short as possible. When computing your credit score, several queries on your credit report will be consolidated into one if they all occur within a short period of time, typically 14 to 45 days.

With rate quotes in mind, you can figure out how much money refinancing can save you and whether it’s worthwhile.

2. Consider fees

Consider whether costs will affect your overall savings before refinancing. Your existing auto loan, for example, may contain a prepayment penalty. If this is the case, you’ll have to pay the original lender money once the new one has paid off the loan. You can find out if there is a penalty in the contract you received from the dealer.

On refinance loans, some lenders add a processing fee, which can cut into the potential interest savings.

3. Understand how your credit will be impacted

The hard inquiry will lower your credit score by a few points almost every time you seek for credit. If you open a new loan account, the average age of your accounts will decrease, which will affect your credit score.

However, both of these indicators play a considerably smaller role in determining your credit score than your payment history, and making on-time payments on your new loan will help you improve your score over time. Refinancing is unlikely to make much of a difference unless you’ve lately applied for a lot of other credit accounts or don’t have a long credit history.

4. Look into multiple types of financing

It’s possible that the first time you borrowed money to buy a car, it was through dealer-arranged finance. Many banks, credit unions, and online lenders, on the other hand, provide car purchasers and owners direct financing.

In general, it’s preferable to begin with the financial institutions with which you already have a relationship. You may be eligible for a loyalty discount based on your existing relationship with the bank or credit union in some situations.

Even if the words are outstanding, don’t stop there. Take some time to compare that quote to other banks’ and lenders’ rate offers. This process may take some time, but the more possibilities you examine, the more likely you are to find the finest auto loan conditions available.

Mistakes to avoid when refinancing your auto loan

Refinancing your car loan isn’t always the best option. When it comes to refinancing, the most common mistake is missing the deadline. If any of the scenarios below apply to you, it might be worthwhile to keep your present loan.

• You’re halfway through repaying your original loan: the amortization procedure reduces your interest payments over the life of the loan. As a result, when you’re still paying down your initial loan, a refinance has a higher chance of saving you money.
• If you’re driving an older automobile with a lot of miles on it, you might be out of luck. Most auto lenders have minimum loan amounts and won’t give you a loan on a car that has lost a considerable amount of value.
• You’ve defaulted on your original loan: When a borrower owes more than the car is worth (also known as being “underwater”), lenders are hesitant to refinance.
• There is a prepayment penalty on your current loan: Paying off your auto loan early can result in a penalty from some lenders. Before you refinance your loan, be sure you understand the terms of your current loan.

Next steps

If you can qualify for a lower interest rate and save money in the long term, refinancing is a good idea. Technically, you can refinance your automobile loan at any time, even after you’ve purchased it.

However, your actual savings will vary depending on where you are in the payback timeline. You may run the numbers for your scenario using a car loan refinance calculator to discover how much money refinancing can save you.

10 years left on mortgage should I refinance

You know that refinancing your present mortgage loan to one with a lower interest rate will save you a large amount of money each month, but your mortgage loan is just 10 years old. The good news is that you can refinance even if your initial loan has only a few months left on it. However, you must consider whether your monthly savings will be sufficient to justify refinancing.

• Costs

Your monthly payment will be reduced if you refinance your loan. However, refinancing is not without cost. Closing expenses are estimated to be between 3% and 6% of a loan’s outstanding balance, according to the Federal Reserve Board. If you owe $100,000 on your mortgage and have 10 years left on your loan, you may expect to pay $3,000 to $6,000 for a refinance.

• The savings

Lowering your interest rate by a point or more can result in significant monthly savings on your mortgage. Your monthly payments would have been around $1,199 if you were repaying a $200,000 30-year fixed-rate loan with a 6% interest rate. If you owe $100,000 and have 10 years left on your loan, you may refinance it to a 10-year fixed-rate mortgage with an interest rate of 3.3 percent, your monthly mortgage payment will be around $979. That’s a $220 monthly savings.

• Does it make financial sense?

You can assess whether the monthly savings are substantial enough to justify a refinance after you know how much you’ll save and how much your refinance will cost. If you save $220 each month while paying $6,000 in closing expenses, it will take little more than two years to save enough money to meet your closing costs. You’ll have more than seven years to enjoy your money now. If you only save $100 per month on your refinance, it will take you five years to save enough money each month to cover $6,000 in closing costs, leaving you with only five years to enjoy your savings.

• Improving your financials

By paying your bills on time and working down your credit card debt, you can increase your chances of earning a lower interest rate and greater savings each month. This will result in a higher three-digit credit score for you. Borrowers with credit scores of 740 or above on the FICO credit-scoring scale typically receive the lowest interest rates. You can also shop around with mortgage lenders who are licensed to do business in your state to see who has the lowest closing charges.

The bottom line

For many homeowners, refinancing a mortgage can be a smart financial choice, especially if they require more than mortgage relief can supply, but not every refinance is a good idea. Before making a decision, make sure to weigh all of your possibilities.