A refi could cut your monthly mortgage payment, but that doesn’t necessarily mean it’s the right move.
There are many reasons to refinance, but here’s what you should know before you act.
Refinancing costs money– If your principal is $500,000, you can estimate 1.5%, or $7,500, as the closing costs on a mortgage refinance. And if refinancing will lower your payment from $3,000 per month to $2,850 per month, you’ll save $200 per month, or $3,000 per year. In this scenario, you’ll recoup the closing costs in two and a half years. If you know you’ll keep the mortgage for longer than those 2.5 years, you might want to refinance.
Use a refinance calculator to see how long it will take for you to recoup the closing costs. If your breakeven point is four years but you only plan to stay in the home for two years, refinancing isn’t a smart move.
A refi could cancel your PMI – If you’re currently paying for private mortgage insurance (PMI) on your loan but have gained a substantial amount of equity in your home, refinancing could enable you to cancel your mortgage insurance.
Your loan balance must be 80 percent or less of your home’s appraised value in order for this to work.
If your first mortgage is 80 percent or less of your home’s value when it’s appraised for the refinance, your new loan wouldn’t require PMI, and this new loan would replace the loan with PMI, thus cancelling your PMI obligations.
You’re rewinding the clock on your loan – When you refinance, you’re effectively resetting the life of your home loan. So if you’ve had your loan for many years, you’ve reached a point in your loan where most of your monthly payment is going to paying the loan down (rather than paying interest). Refinancing the loan will change this dynamic, so most of your payment is going to interest rather than paying your loan down.
Ask your lender to do a side-by-side loan amortization comparison so you can see how fast you’ll pay off your existing loan versus a new loan. Also ask them to show you how much faster you’d pay off the new loan if you took the savings from a refinance and applied it as an extra monthly pay-down on the new loan.
Your equity could be a good source of cash– A cash-out refinance lets you take out a new mortgage for more than the amount you owe on your current loan and then pocket the difference — typically up to 80 percent of your loan-to-value ratio. That can be a good move, depending on how you’re planning to spend the money.
If you’re going to use the cash to build an addition to your home that’s going to increase your property’s value, taking a cash-out refi makes sense. But keep in mind that cash-out refinance rates are slightly higher than rates for non-cash-out refinances.
If you’re going to use the money for discretionary spending, such as a vacation, think twice. It’s not advisable to use cash out proceeds for discretionary spending, although lenders don’t prohibit you from doing this.
One caveat: If home values in your neighborhood are decreasing, now may not be the right time to tap your equity. Before you pull equity from your home, you need to weigh the costs and benefits.