Interest rates are at an all time low. Low enough that even people with a great interest rate are thinking about refinancing their mortgage. The timing can be tricky though. When does it make sense to refinance you mortgage?
That’s a question I struggled with last year. Interest rates were falling through the floor and I had to make the decision on if it was worth it to refinance my home.
There’s several important things to consider. This is what I looked at when I was making the decision for myself.
Do You Have Enough Equity To Refinance?
We bought our home when lenders were playing fast and loose. Almost anyone could get a mortgage and nearly as many people could get one with a very minimal down payment. I think we put 3% down when we bought our house.
Today it’s a different story. You would be hard pressed to find a lender that would do a 97% note. Even the most liberal lenders are looking for 5% down and most prefer at least 10% down.
A lot of these lenders have been burned on mortgages that are underwater. They don’t want to take the chance that their collateral will be worth less than what you owe if they have to foreclose on the property.
The bigger the down payment, the less risky it is for the lender.
Most people don’t think of a down payment when you’re talking about a refinance. But the reality is you are getting a brand new loan to pay off your old loan and the lender will follow the same guidelines as if your were financing the property for the first time.
If you aren’t sure what your house is worth, look it up on Zillow. It can at least give you a ballpark figure of what the property is worth.
If you owe 90% or less of the estimated value of the house, then you shouldn’t have a problem finding a lender that will help you with a refinance.
Watch Out For A Prepayment Penalty
Something else to look into before you move ahead with a refinance is to see if your current mortgage has a prepayment penalty.
You will likely have to pull out your closing documents from when you bought the house (you know where those are right?)
Read through the note and see if there is a prepayment penalty. If reading legal documents makes you want to jump off a bridge, you can always give your lender a ring and ask them. At the end of the day though, it’s what’s in your note that matters. (So be wearly of the call center rep that could tell you the wrong thing.)
Comparing The Costs and Benefits of Refinancing
Now if you have enough equity and you aren’t going to be hit by any prepayment penalties, the next thing you have to think about are the closing costs. Just like when you purchased your home, the closing costs when refinancing can be substantial.
The loan origination is usually 1% of the amount financed plus you have the appraisal, title insurance, processing and underwriting fees, etc.
As a general guideline, closing costs on a refinance will run about 2% – 3% of the amount being financed.
To know if it make sense to refinance, the amount you save by refinancing should be greater than what it costs to refinance.
Let’s run some numbers:
In this example, the refinance would pay for it self in 16 months and you would save over $65,000 in interest!
As long as you are planning on living in the house for more than 16 months, it would make sense to refinance.
That’s really all there is to it. Just simple math to see if the benefits outweigh the costs.
When we refinanced, it paid for itself in 8 months! If you have a high interest rate, refinancing really can save you a ton of money.