When to Refinance Your Mortgage (And How to Do It)
By the time you’ve found this page, you’ve probably already learned that refinancing your mortgage is more complicated than calling your lender and getting it changed. There’s going to be some paperwork and careful thinking you have to do.
Luckily, we’re here to help. The hassle of refinancing will be well worth it if it’s right for you.
We recommend that you hire a loan consultant to help you with this process. An expert can help clarify all the confusing details and negotiate with lenders and banks for you to find the best deal.
In Santa Barbara, CA Diana MacFarlane is the best local mortgage lender. She has earned herself a reputation that gives her connections and insights that you won’t get with anyone else. If you’re not in the area, Caliber Home Loans’ branch locator should be able to help you find a trusted loan consultant.
Let’s go through the basics of why people refinance their mortgage and what are some easy questions to ask yourself to decide if refinancing is for you.
What Is Refinancing?
Briefly, to clear up any confusion that might be out there here’s a simple explanation of what refinancing is:
Refinancing is renegotiating your original mortgage so you can adjust what you are paying. You can adjust pretty much everything about your mortgage from how many years you took the loan to the interest rate.
This is different than taking a second mortgage on your home, think of this like taking a new, refreshed first mortgage.
Keep in mind that means you’ll be paying for closing costs again (unless you qualify for reduced or no cost refinancing programs). So you’ll want to be sure that the savings you lock in aren’t canceled out by the fees you’re charged.
Why Refinance Your Mortgage?
Saving money is the goal of refinancing.
(Unless you’re trying to get cash out of your house, or you invest in real estate and are trying to utilize earned equity towards other investments.)
Exactly how you go about achieving that goal depends on you. Your current financial situation and your long-term plans for your house will make all the difference in how you refinance your home loan.
That being said, the two broad ways that you can save money through refinancing are by:
- Lowering your monthly payments.
- Paying off your house sooner, saving money in the long term.
These are two very different ways to get the same thing; money in your pocket.
Lowering Your Monthly Payments
To lower your monthly mortgage payments, there are three things you need to consider. Any combination of the following three factors can lead to savings through refinancing.
You should check how today’s interest rates compare to what you are currently paying. If they are significantly lower, you can take advantage of savings.
As a rule of thumb, you are looking for a 2 percentage point difference (such as a drop from an 8% to a 6% interest rate). This difference should cover the costs of refinancing and make the process well worth your while.
However, even if there isn’t a 2 percentage point difference, you might still be able to lower your monthly payments. There are new low cost no cost refinancing programs that are available to qualifying individuals, making this a possibility.
If you are planning on staying in your current home for at least three years, paying for points on your mortgage can lock in savings. Paying for a point means putting forward money now to save money on your interest later, and each point costs as much as 1% of the loan amount.
You would be paying to lower your interest rate, lower your monthly payments, and save money in the long run.
If you’ve been in your current home for at least three years, you might be able to reduce your monthly payments simply by refinancing.
By now, you’ve reduced your balance by several thousand dollars and can capitalize on that.
For example, out of the $250,000 you might have initially taken your mortgage for, only $200,000 might still be due. So you should be able to refinance and pay less on principle and interest while keeping the term (length of time) of your loan the same.
If that doesn’t make sense at first, think of it like this: Refinancing is like taking out your mortgage for the first time, it’s just like buying a new house. The cheaper the house, the lower your payments.
By paying for your house for a few years and growing your equity in it, you have essentially made your house “cheaper” by paying off the debt that you owe on it. So why not take advantage of it?
Consult with your loan consultant to get clarity on the details and see if any of these paths is right for you. If any are, you can immediately lower your monthly payments.
Pay off Your Mortgage Sooner
This sentence is going to be extremely counterintuitive but stay with me.
You can increase your monthly payments to save money.
Here’s how it works:
This method is looking at the long term. By renegotiating your mortgage to pay more each month, you will be paying off what you know faster. In trade, you get lower interest rates and ultimately save a lot of money on the total amount you pay for your house.
That’s pretty much it. Although, the other factors we have mentioned to reduce your monthly payments still stand and the savvy homeowner would take advantage of as many of these saving options as they could.
Should You Refinance Your Mortgage? Questions to Ask Yourself
What’s My Goal?
Clearly, the first step is to decide on what you are trying to achieve with refinancing. Without a clear goal, you can’t get anything done.
So ask yourself, am I refinancing to lower my monthly payments, pay off my home faster, to take cash out so I can use it elsewhere, or to use my equity towards other investments?
Can I Afford It?
Refinancing isn’t all about saving. It’s about balancing your spending with your savings and making sure you still come out on top. There are going to be costs associated with refinancing, so be sure that you have the money to pay for them.
Especially if you are trying to lower your monthly payments, calculate whether the savings you are trying to get for are going to be canceled out by miscellaneous fees (closing costs). If they are, refinancing is obviously not worth it.
Normally, these expenses will end up costing about 2-5% of your home’s total value. So keep that in mind as you’re saving up and trying to figure out how much you’ll be paying up front.
If you’re looking to save money in the long term and aren’t too concerned with initial costs, immediate affordability the biggest factor for you. However, that doesn’t mean you can just ignore these costs to make them go away. Don’t overlook these expenses and figure out exactly how much refinancing is going to cost you.
The only exception is qualifying for programs that allow you to pay lower or no closing costs. Look into no-closing-cost programs that are available to see if you qualify. If you do, still ask yourself these other questions to make sure refinancing is right for you because those programs don’t guarantee you’ll be saving money by refinancing.
So keep in mind that there are closing costs, learn how much they’re going to cost, and decide if it is within your budget.
How’s the economy?
This is the biggest factor in determining how much you are going to be able to save with refinancing.
If the interest rates are low and the economy seems stable, you can likely save money by refinancing.
If the interest rates are high and the economy is failing, refinancing probably won’t be a good way to save money. Unless you bought your house at an even worse time.
The only time you should still consider refinancing in a bad economy is if you are trying to take out cash on your house. Refinancing is still viable for this in a bad economy, though you will likely be losing some money so use it as a last resort.
How Long Do I Plan To Live Here?
How long you have been or plan to be in your house influences some integral factors of the refinancing process.
If you are planning to be in your house for at least another 5 years, refinancing can be great. There are certain methods you can use to save money that wouldn’t make sense otherwise. Such as paying for points or increasing your monthly payments to reduce your interest rate.
If you are planning on moving within the next 5 years, it might still make sense to refinance, but for very different reasons. Such as refinancing to switch from a fixed rate to an adjustable rate mortgage to possibly save money (fixed rate vs. adjustable rate mortgage).
The specific can get cloudy, but in general, the longer you plan to live in the same house, the more sense it makes to refinance.
You Decided: Refinancing Is For Me!
Great! Interest rates are the lowest they’ve been in years (at the time of writing this in late 2016) making it an excellent time to refinance.
But before you go guns blazing to your lender, we recommend hiring a loan consultant. They are experts who can help you understand all the nuances of mortgages and can go to the banks for you to get you the best deal.
If you’re in Santa Barbara, we’re the best loan consultant in town. But if you are located elsewhere you can use Google or Caliber Home Loans’ branch locator to find a loan consultant near you.
If you decide to refinance without a loan consultant, then keep doing what you’re doing right now: research. Take your time and find the best deal.
Enjoy the savings (or the cash)!
You Decided: I Won’t Be Refinancing
That’s fine too. The important part is you did your research and avoided a costly mistake.
Whatever your circumstance, certainly keep your eye on interest rates and keep asking yourself if financing is right for you. Because hopefully one day it will be, and then you can get what you need out of refinancing your mortgage.