When Does a Mortgage Refinance Make Sense?
Refinancing your mortgage could potentially lead to thousands of dollars saved if the timing is right. Otherwise, you may end up with worse mortgage terms than when you started and actually end up losing money over the long run.
So when is refinancing a mortgage the right financial decision? It really can depend on the wider economic climate, the property value in your area, and of course, your own personal finances, including things like your credit score.
On the other hand, replacing your mortgage through refinancing may not be wise if your current financial situation is not ideal, or if closing costs outweigh potential refinance savings. Just like with the original mortgage process, there are the same closing costs for a mortgage refinance.
You can use True Quote Mortgage’s mortgage refinance calculator, that accounts for closing costs, to more accurately estimate what refinancing your home loan will save you, if anything at all.
In addition to that calculator, check out this article that will inform you on the specific circumstances that may call for a mortgage refinance.
Situations When a Mortgage Refinance Makes Sense
When it comes to deciding if refinancing your mortgage is the right financial decision, there are really four main instances where a mortgage refinance is likely to make sense.
These times include when your credit score has improved, when mortgage interest rates are down, when mortgage rates are up and you are looking to switch from an adjustable-rate mortgage to a fixed-rate mortgage, and when your home’s value has increased.
Let’s run through each situation in more detail.
Refinancing When Your Credit Score Has Improved
If your personal finance situation has drastically improved from the time of your original mortgage, it may be time to replace that mortgage through refinancing.
An improved financial situation will be reflected in your credit score, which can greatly impact the mortgage terms you receive, specifically the mortgage interest rate. If your credit score has gotten better since your original home loan, than a mortgage refinance will likely lead to a better interest rate, which could save you thousands.
But, this plays both ways. If your credit score has decreased from when you first took out a mortgage, than refinancing your mortgage could lead to a worse home loan rate. Not to mention, the hard credit inquiries made by the lender during the refinancing process will only further harm your credit score.
Refinancing When Mortgage Rates Are Down
Mortgage interest rates do not just occur in your own personal vacuum, and change according to the overall state of the U.S. and global economy, inflation, and the current policy of the U.S. Federal Reserve.
Mortgage rates throughout the U.S. may have lowered from the time when you took out your initial home loan. By refinancing your mortgage through a rate-and-term refinance during this kind of nationwide-mortgage rate drop, you may be able to secure a lower interest rate and save thousands in monthly mortgage payments.
Additionally, if economic indicators are pointing towards a long period of decreased mortgage rates and you have a fixed-rate mortgage, it may make sense to refinance your mortgage into an adjustable-rate mortgage (ARM). With an ARM, you can take advantage of falling mortgage interest rates and monthly home loan payments may continually decrease.
Refinancing When Mortgage Rates Are Up and You Have an ARM
Just as switching from a fixed-rate mortgage to an ARM makes sense if mortgage rates are projected to keep going down, moving from an ARM to a fixed-rate mortgage makes sense if mortgage interest rates are heading upwards.
With an ARM, you are susceptible to sudden interest rate hikes, which may make your monthly mortgage payments hard to predict and hard to meet. If economic trends are pointing to increasing interest rates, making the move to a fixed-rate mortgage with a locked in interest rate could protect you from unaffordable mortgage rate increases.
Refinancing When Your Home’s Value Has Increased
Finally, if the value of your home has increased, refinancing your mortgage could be advantageous.
In this instance, you would want to utilize a cash-out refinance, which means you take out a larger mortgage than what you still owed on your existing mortgage and receive that difference in cash.
For example, let’s say you originally took out a $200,000 mortgage on a $250,000 house and have already repaid $100,000 so that you only owe $100,000 on your mortgage. During that time, your home’s value has surged to $300,000.
Since your home’s value is much greater than your outstanding mortgage balance, you could refinance that existing $100,000 mortgage for a $150,000 mortgage and receive the additional $50,000 in cash.
Cash-out refinances are great in this situation, and the cash you receive is best used for home improvements or renovations that will further increase the value of your property.
Calculating the Break-Even Point on a Mortgage Refinance
As mentioned before, refinancing your mortgage means that you will have to budget for the same closing costs you paid for your original mortgage. These closing costs can rack up and you can quickly approach the break-even point on a mortgage refinance.
To find the break-even point, you will need to sum together all mortgage refinance closing costs and then figure out how many years it will take you to recover the closing costs because of your monthly mortgage payments that have been reduced from refinancing.
So, the break-even point is the point when you finally break even on the refinance closing costs. Because of this, mortgage refinancing really only makes sense if you intend to stay in the home for longer than the break-even point. If you leave the home early, you will likely be losing money than if you had just kept the initial home loan.
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