When paying off a mortgage, one of the most important questions you’ll need to ask yourself is when to refinance, as this could lead to substantial savings.
In order to get savings on your new loan, you’ll need to refinance under favorable conditions. Here are tips on refinancing a loan:
Two types of refinances
There are two types of refinances, and you’ll need to decide which one best suits your financial goals:
- Rate-and-term refinancing– This lets you refinance the remaining balance on your mortgage for a lower interest rate and a term or length of time you can comfortably pay it off.
- Cash–out refinancing– This lets you take on a new mortgage for more than you initially owed. This is one way to access the equity on your home, which can be used to pay off expenses, consumer debt, or make purchases.
The benefits of refinancing
Successfully refinancing a loan comes with the following benefits:
- Lower interest rate
- Shorter mortgage term
- Tap home’s equity
- Consolidate debt
- Switch loan types
In general, refinancing a loan helps ease your debt burden, allowing you to channel your resources elsewhere. Whether you intend to send your child to college, travel more, or simply funnel more money into your savings account, then refinancing will help.
When to refinance
A rule of thumb is to see if you can reduce your interest rate by at least 0.75 to one percent. Lowering your interest rate helps you save money and build equity in your home at a faster pace.
Although adjustable-rate mortgages (ARMs) can start out with lower rates than fixed-rate mortgages (FRMs), adjustments can result in rates that are higher than those of the latter. When this happens, switching to an FRM loan translates to a lower interest rate and protects you from rate hikes in the future.
Doing the opposite can also be beneficial if interest rates continue to dip – periodic adjustments to an ARM loan will lead to decreasing rates and lower monthly payments.
Determine the term for the refinanced loan
You’ll get cost savings if closing costs for the refinance are rolled into the loan amount. If this isn’t the case, then you’ll need to ask your new lender to make calculations based on how many years you plan to stay in the home versus the time it will take to recoup closing costs.
Refinancing typically costs three to six percent of a loan’s principal, which often takes years to regain with the savings that come with a lower interest rate and shorter payment term. Hence it will only be beneficial if you intend to live in your home for a long time, as this will help you break even.
If you qualify for a lower rate and you’re well into a 30-year fixed rate mortgage, then you might want to consider refinancing for a 15 or 20-year term. Even if you don’t see lower payments, you’ll save money because of the shorter amortization period.
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