Interest rates on mortgages are at all time lows; does that mean you should refinance as soon as possible?
Maybe–and maybe not.
Interest rates may be lower than they’ve ever been, but never has the issue of refinancing been more complicated. For one thing, it’s harder than ever to qualify for a loan at the best rates, and for another, today we have to consider falling property values which is something that hasn’t existed since the Great Depression.
What are the pros and cons to refinancing your mortgage?
The reasons you SHOULD refinance – Pro
If your credit and income situation are strong enough, and your home has sufficient equity, there are several tangible benefits to refinancing your mortgage.
Lower house payment.
The most obvious reason to refinance is to lower your house payment. Not only will that make your payment easier to handle, but it can free up money for savings and investment creating a double-win situation.
Lower interest rate.
While this may seem part and parcel of a lower house payment, it has advantages all its own. The lower your interest rate, the less of your payment will be devoted to interest expense and more will go toward principal. This will mean faster equity build up and create an opportunity to pay off the loan early.
[Related: Check out mortgage refinance rates in your area.]
Shorter term/faster payoff.
Not all refinances are designed to lower your monthly payment. Some are set up to lessen the loan term to enable the mortgage to be paid off sooner.
If you have a 30 year loan with 25 years remaining, and you refinance to a 15 year loan, you will move the payoff of the loan up by 10 years. If the rate drop from the 30 year loan to the 15 is large enough, you may even be able to do this without increasing the monthly payment—another example of a double-win!
Staying ahead of house price declines.
This is something no one thought much about until a few years, but now it’s something that can’t be ignored.
In many markets, house prices have been declining steadily, and one of the best ways to deal with this is by accelerating the pay down and eventual payoff of your mortgage. If a refinance helps you to do this, then it’s a step well worth taking by itself.
The reasons you SHOULDN’T refinance – Con
As compelling as the benefits of refinancing are, there are some reasons why doing one may not work for you, or why you may not even be able to.
Refinances aren’t free, even if they result in lower rates and monthly payments.
Those benefits are paid for through closing costs—origination points, appraisal fees, legal and title fees, insurance and taxes among them. Collectively those charges can (and usually do) add up to thousands of dollars. They can be paid for in a variety of ways: out of pocket, adding them to the new loan balance or lender paid through a higher loan rate, but each will lower the benefit of the refinance in some way or another.
Recasting and extending the loan term.
Often the greatest savings on a refinance comes from extending the term of a loan.
For example, when you refinance a 30 year loan with 25 years on it back to a new 30 year loan, you’ll lower your monthly payment, but you’ll also add five years to the payoff. That will help to keep the monthly payment affordable, but it will extend the term of the loan when it does. You may find that adding five years worth of payments to the back end of the loan doesn’t justify the savings on the monthly payment.
Moral of the story: if you refinance your mortgage, make sure the new loan doesn’t exceed the number of years remaining on the current one. A loan with 25 years remaining should be refinanced to a loan no greater than 25 years.
You will only get the best rate if your credit is excellent.
In order to get the mortgage rates you see advertised you’ll have to have excellent credit, a sufficient income (with a steady history of earning it), plus “reserves”—money left over after closing in an amount equal to several months of your house payment.
A lot of people don’t have this kind of profile after the job losses of the past few years, and if you’re one of them, you won’t get the advertised rates.
Your property may not have sufficient value.
If your home has declined in value faster than your mortgage has, you may not have enough equity to get the best loan rates—or even any loan at all.
If you can get all of the above working in your favor, a refinance can be a real step forward in your financial plans. Just make sure that what it is your doing will be a true benefit, and not a matter of rearranging the numbers to make it seem as if there’s an advantage.