You may have seen news headlines like the one above revealing the continued decline in mortgage rates. Mortgage rates declined to 6.13% last week, the lowest in two years.
Refinancing your mortgage can feel like rebooting your computer. Sometimes, it's exactly what you need to make everything run smoother, but other times, it might be an unnecessary hassle. If you're wondering whether it's time to refinance your home loan, let's break it down into simple terms to help you make an informed decision.
What Does Refinancing Mean?
Refinancing your mortgage means replacing your current home loan with a new one. This new loan typically has different terms, which might include a lower interest rate, a different loan duration, or both. It's like swapping out an old phone plan for a better deal that more closely fits your current needs.
Will Mortgage Rates Continue to Drop?
There is no way to know for sure. Nobody has a crystal ball. The challenge facing many of us is our recency bias toward rates below 4%.
For those of you who are wonky, you fully understand that this was likely a once-in-a-lifetime opportunity created from the intersection of the unraveling of the financial collapse in 2008 and the 2020 pandemic, when fearful investors were attracted to safer products such as Treasury and mortgage bonds, pushing yields—and rates—lower.
It's essential to keep a perspective on the bigger picture.
30-Year Fixed Rate Mortgage Average in the United States
Why Consider Refinancing?
As you can see below, housing prices spiked anomalously during the pandemic. You may have had to overpay to purchase a home.
Median Sales Price for New Houses Sold in the United States
Couple this with higher mortgage rates, and your monthly mortgage payments could be costly. With that in mind, there are several good reasons to think about refinancing your mortgage:
Lower Interest Rates
The most common reason to refinance is to secure a lower interest rate. If interest rates have dropped since you got your original mortgage, refinancing could reduce your monthly payments and the total amount you'll pay over the life of the loan.
Shorten Your Loan Term
If you're making more money than you were when you first bought your house, you might want to pay off your mortgage faster. Refinancing to a shorter-term loan, like going from a 30-year to a 15-year mortgage, can save you a lot of money in interest in the long run.
Convert Between Adjustable and Fixed Rate
If you initially took an adjustable-rate mortgage (ARM) and rates are starting to climb, you might feel more secure with a fixed-rate mortgage. This gives you a consistent payment for the rest of your loan period.
Tap into Home Equity
If your home has increased in value or you've paid down a significant portion of your mortgage, refinancing can allow you to access some of that equity. This is called a cash-out refinance. You can use this money for home improvements, paying off high-interest debts, or other important expenses.
Consolidate Debt
Some people refinance their mortgages to consolidate other debts (like credit card debt) into a lower-interest rate loan. While this can simplify payments and reduce interest costs, it also risks their homes if they fail to make payments.
When Should You Refinance?
Refinancing isn't free. There are fees involved, like appraisal fees, processing fees, and closing costs, which can range from 2% to 5% of your loan amount. Here's a simple rule of thumb:
Break-Even Point
Calculate how long it will take for your monthly savings from refinancing to exceed the costs. Refinancing might be a good idea if you plan to stay in your home longer than this break-even point. Your lender will calculate the break-even point for you.
Credit Score
Your credit score affects your refinancing options. You might get better terms if it's improved since you got your original loan.
Financial Goals
Consider what you're trying to achieve. Is it lower monthly payments, paying off your home sooner, or getting some extra cash for a big project? Your goal will guide whether refinancing makes sense.
How Do Lenders Calculate My Risk?
Lenders must determine how much risk they can take when lending you money or refinancing your home. If you plan to shorten the length of your loan when you refinance, lenders might use the same calculations they use in the initial loan origination process.
Should You Refinance?
Refinancing can be a great financial move if it aligns with your personal and financial goals. Consider your reasons for refinancing, check the numbers, and perhaps talk to a financial advisor. Remember, it's not just about today's benefits but also how it fits into your long-term financial health.
If you're still unsure, consider this: if refinancing helps you sleep better at night by reducing your payments, shortening your loan term, or stabilizing your rates, it might just be the reboot your financial life needs.
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