If you’re looking to refinance an existing mortgage, there are a few easy calculations you can do to make sure that refinancing will actually be worth it. Saving money is the main reason people want to refinance.
Refinancing is just buying out your old mortgage with a new one that has better terms. So how do you know if refinancing will help you save money?
Remember, refinancing costs money to close the loan, and sometimes has associated fees, just like you had when you first got the mortgage. Do you have enough money in savings to cover closing costs?
Would you live in your home two to three years after refinancing? If not, it may not make financial sense for you to spend the money to refinance. The savings from a refinance may not offset the costs.
Here are a few more factors to consider when refinancing.
1. Interest Rates
Having a mortgage with a high interest rate is one of the most common reasons to refinance a mortgage. The lower the interest rate, the less your monthly payment will be, and the lower interest you will pay over the life of the loan.
It’s best to have a difference of at least 1 percent between your current rate and the one you’re refinancing to. Remember, there are costs associated with a refinance. If the difference in interest rates is less than 1 percent, the savings may not be sufficient for the refi costs to make economic sense.
2. Adjustable-Rate vs. Fixed Mortgages
Another reason to refinance is to move from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. The interest rates on an ARM fluctuate. They generally start out at a low interest rate, but the rate can move up if interest rates do. In a fixed-rate mortgage, the interest rate is the same for the life of the loan, so payments are always the same.
If you have an ARM in a period of rising interest rates, such as we are currently in, it can be better for your pocketbook to refinance to a fixed-rate loan.
If you obtained a fixed rate in a period when interest rates were high, it’s a good idea to refi once interest rates drop.
3. Private Mortgage Insurance
Lenders with less than a 20 percent down payment are required to have private mortgage insurance (PMI). Loans guaranteed by the U.S. government, such as Federal Housing Administration or other loans, require low or no down payments, so they have PMI for the life of the loan. The only way to remove it is refinance once you have 20 percent equity in your home.
4. A Better Credit Score
Many lenders will give more advantageous interest rates to people with higher credit scores. The higher your credit score, the less risk to the lender.
If you have improved your credit score significantly, you may be able to refinance at a lower interest rate.
5. Changing Loan Term
Many people want to refinance to change the loan term, usually from a 30-year mortgage to a 15-year mortgage. Refinancing to change loan term is usually unnecessary since you could just make additional payments on the principal. This way you save on refinancing costs and still pay down your home in 15 years instead of 30.
The only two reasons you should refinance to change loan term is 1) if your current lender has a prepayment penalty or 2) if changing your loan term will decrease your interest rate by at least 1 percent.
If refinancing will help you save money, the next step is to choose the best mortgage for you. Here’s a step by step cheat sheet to learn about the various types of mortgages by PSECU to help.
Disclaimer: This post is sponsored by PSECU, a Pennsylvania-based credit union.