My kitchen counter is littered with unsolicited mail from banks and lenders. All of them offering me deals to refinance my home mortgage.
If you’re a homeowner I’m sure you’re getting the same kind of offers. Lenders across the country are trying to convince mortgage holders that now is the perfect time to refinance.
Mr. Patterson and I have been talking about refinancing since we started receiving offers during the past several weeks. But it’s hard to know if it’s the right thing to do. Sometimes we are for it and sometimes we are against it. Basically we aren’t sure what to do. There are so many things to consider when deciding whether to refinance our mortgage or not.
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Ideally we would like to refinance into a lower rate so we can save on the amount of interest we pay over the course of the loan. The lower the interest rate you get, the less you pay in interest to the lender. Other homeowners may choose to refinance for different reasons.
Many homeowners refinance to lower their monthly mortgage payment. It helps homeowners with trouble paying their bills increase their cash flow.
If you didn’t put twenty percent down when you bought your home you would have had to pay PMI, private mortgage insurance. Once the equity in your home increased to twenty percent or higher, refinancing will get rid of your PMI. Getting rid of PMI could save you $100 or more a month.
Refinancing isn’t always about lowering your monthly payment. Sometimes homeowners refinance their loans into shorter term loans to save on the amount on interest they pay. This option usually has homeowners refinancing from thirty year loans to fifteen year loans. It pays off your home loan much faster and saves you thousands of dollars over the life of your loan.
Now, this can be a great financial tool, but only if you use it correctly. Used incorrectly you could wind up paying more money over a longer period of time than you ever thought you would.
Homeowners who refinance often extend the life of their loans. Replacing a mortgage that has twenty years remaining with a new, thirty year mortgage will reduce your monthly payment but it will also result in a higher total amount paid in interest over the life of the new loan. For example, a $300,000 mortgage with a five percent interest rate will end up costing a homeowner about $580,000 over the course of a standard thirty year loan. But if you refinance at any time during those thirty years and extend your loan to lower your monthly payments, you’ll pay even more than that staggering figure.
It’s also important to remember that refinancing isn’t cheap. The cost of refinancing our home is a major factor in our decision. When you refinance your mortgage loan you have to pay closing costs just like you did when you first bought your home. Closing costs usually consist of fees for services like a survey, appraisal, title insurance, application, legal services, settlement fees, document fees, etc.
Typical refinance closing costs range from two to three percent of the loan. If refinance costs are nearly equal to what you would save by refinancing, then it may not be worth the trouble. To calculate if the lower monthly payments you will get by refinancing will be worth it for you in the long run divide the total cost to refinance by the amount of money you will save each month. This will tell you how long it will take for you to start seeing the savings of a refinance. Take a look at this example:
Total cost: $5,200
Current monthly payment: $1,600
New monthly payment: $1,400
$5,200 / ( $1,600 – $1,400 ) = 26 months
This calculation shows that you would need to stay in your house for another two years and two months before you could start enjoying your savings. If you plan to stay in your house for just another two to three years, it is not worth it to refinance. The rule of thumb is to refinance when you can recover the cost of refinancing within 24 months.
With all of these mitigating factors it’s hard to know when refinancing is right for you but there are a few situations in which the answer is cut and dry. Never refinance if you are:
* Planning on selling your house in the next few years.
* Underwater on your mortgage. Lenders require you to have at least twenty percent equity in your home to refinance.
* If you plan to use the money you save to buy depreciating assets, like cars or furniture, or unnecessary expenses like vacations or a wedding.
It doesn’t cost anything to look into refinancing your home. Get an estimate of costs from your lender to help you decide if refinancing your home loan is the way to go. There are also numerous online calculators that can help you decide. I like bankrate.com’s calculator.
For now Mr. Patterson and I have chosen to wait it out. We’re hoping we’ll continue to get offers from lenders to refinance offering even lower interest rates. When we’re able to get an interest rate two percentage points or more lower than our current one, we’re going to refinance.
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