Mortgage Refinancing: How to Know When the Time Is Right

Managing Your Mortgage, Mortgages
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mortgage refinancing how to know when

Everyone loves saving money, especially when it comes to most homeowners’ largest monthly expense: the mortgage. Maybe you’re looking to cut that bill by refinancing your mortgage. Or maybe you’re thinking about refinancing because you’re afraid interest rates are heading up and it’s your last chance to grab a better deal.

Mortgage rates are still historically low and you may have plenty of loan options, but take some time to figure out whether refinancing is your best move right now. How long you plan to stay in your home, your financial goals and your credit profile all play a role in your decision about whether — and when — to refinance.

To get an idea of when it makes sense to refinance your home, we talked to two lending experts: Katie Miller, vice president of mortgage lending with Navy Federal Credit Union in Vienna, Virginia, and Tony Julianelle, Denver area sales manager for home mortgages with Wells Fargo.

Here are a few questions you should ask yourself to help decide whether now is a good time to refinance:

Will mortgage rates rise soon?

When the Federal Reserve announced in December 2015 it was raising short-term interest rates by 0.25%, many people feared a jump in mortgage rates. But mortgage rates don’t move in lockstep with short-term rates, Miller says.

In other words, don’t expect a quick rise that will price you out of refinancing your home anytime soon. There’s still time for you to pay off high-interest debts or boost your credit score — and better position yourself to qualify for a good refinance loan.

“Rates are still quite low, and we’re seeing a good number of refinance applications coming in,” Miller says. She adds that many people who purchased at the market peak only to see housing prices crash have finally regained enough equity in their homes to benefit from a refinance. “We are seeing more people take advantage of low interest rates with cash-out refinancing to pay for home improvements.”

Mortgage rates are forecast to increase slightly in 2016, but until they reach 5% or more, Miller says, you’ll likely get a competitive rate as long as your credit score is good and you show proof of steady income. (Tip: Using a mortgage calculator can help you get a sense of what kind of rates you might expect.)

How much would I save on my monthly payment?

To calculate your potential savings, you’ll need to add up your costs of refinancing, such as an appraisal, a credit check, origination fees and closing costs. Also, check whether you face a penalty for paying off your current loan early. Then, when you find out what interest rate you could qualify for on a new loan, you’ll be able to calculate your new monthly payment and see how much, if anything, you’ll save each month.

You’ll also want to consider whether you have at least 20% equity in your home — the difference between its market value and what you owe. Check the property values in your neighborhood to determine how much your home might appraise for now. Don’t rely on online home value estimates alone — they’re often way off — but online sites can point out recent sale prices for similar homes near you. A local real estate agent can give you an idea of what your home’s worth, too.

Your equity amount is important because lenders usually require you “insure” the mortgage — protect their financial interests in the event you default — if you have less than 20% equity. Mortgage insurance is not cheap and is built into your monthly payment, so be sure you wrap it into your calculations about potential savings.

Once you add up all the costs of a refinanced loan, you can compare your “all-in” monthly payment with what you currently pay.

Will the savings be enough to make refinancing worthwhile?

You’ll spend an average of 3% to 6% of the loan amount in closing costs, so you need to figure out how long your monthly savings will go toward recouping those costs. For instance, it would take 30 months to break even on $3,000 in closing costs if your monthly payment drops by $100. If you move during that 30 months, you’ll lose money in a refinance.

Think about whether your current home will fit your lifestyle in the future. You’d be surprised, but a lot of people don’t. If you’re close to starting a family or having an empty nest, and you refinance now,  there’s a chance you won’t stay in your home long enough to break even on the costs.

Homeowners who are deep into repaying their mortgages should also think carefully before jumping into a refinance, Miller says. If you’re already 10 or more years into your loan, refinancing to a new 30-year or even 20-year loan — even if it lowers your rate considerably —  tacks on interest costs. That’s because interest payments are front-loaded; the longer you’ve been paying your mortgage, the more of each payment goes toward the principal instead of interest.

Is it time to change the type of loan I have?

Take your prediction on how long you’ll stay in your current home and then think about the details of your current mortgage. How those factors play off each other could have a role in your decision.

Let’s say you bought a home with an adjustable-rate mortgage for an initial term of five years at around 3%. You plan to stay put for several more years. If you’re nearing the time when the adjustable rate can reset and move higher, you might benefit from refinancing to a 20- or 30-year fixed-rate mortgage to get a set interest rate that won’t fluctuate.

Conversely, if you know you’ll be moving in a few years, refinancing to an ARM from a longer-term fixed loan can help you save more money because lenders offer lower interest rates on those loans.

>> MORE: Tips to reduce your home expenses and maximize your refinance savings

What does my credit look like?

Has your credit score and payment history improved since you got your mortgage? If so, you might qualify for a better interest rate, which will help you save more per month and break even sooner.

On the other hand, hitting a rough financial patch (or two) can do a number on your credit, and that affects your ability to qualify for a refinance loan and also the rate you’ll get. If you’ve been late on a credit card payment, bought a new car or taken on student loans, your credit score might be lower than it was when you took out your original loan. Before refinancing, you might want to do some credit repair.

“If you’re struggling with payments, automate everything so you don’t miss any,” Julianelle says. “Also, look at the ratio of your outstanding credit card balances to the credit limit. If your credit report shows outstanding balances near the limit, that shows high usage. You want to keep that ratio as low as possible by paying off your credit card balances each month in full, because that can make a big difference in whether or not you qualify for a new loan.”

Another smart move: Figure out how much you pay in credit card and other high-interest debt each month. See if the money you’d spend on closing costs would be better spent paying down those bills down instead of refinancing your home. Or, perhaps commit to using the monthly savings you reap from a refinance to pay those debts.

Bottom line

Before you dive headfirst into refinancing, sit down with a lender and do the math to see if you’d break even in a period of time that makes sense. Take a thorough inventory of your financial goals, and think about how your current home will fulfill future space and location needs.

Don’t forget that if you’re struggling to pay your mortgage each month and you don’t qualify for a conventional refinance loan, HARP is a government loan refinance program expiring at the end of 2018 that can lessen your financial burden.

Saving money on your mortgage helps you build wealth, and who doesn’t love doing that? If now isn’t the ideal time to refinance, keep plugging away on your current mortgage payments and keep your credit in good order so you’ll be ready to strike when the time is right.

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Deborah Kearns and Hal Bundrick are staff writers at NerdWallet, a personal finance website.

Email: dkearns@nerdwallet.comhal@nerdwallet.comTwitter: @debbie_kearns@halmbundrick

Updated Sept. 20, 2017.


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