It has been widely reported that mortgage rates are at historic lows so now may indeed be a good time to refinance. However, there are a few factors to consider before rushing into it.
Things to consider:
1)Upfront costs: Refinancing will require many of the same costs and fees you incurred when you got your initial mortgage. Make sure you are incorporating these costs in your consideration. Some potential costs involved: application fee, appraisal fee, credit check, title search, title insurance, survey, origination fee, discount points, lawyer fees, PMI, etc. Some lenders offer a low or no cost refinancing option in which you can negotiate to waive some or all of the refinance costs. However, this often results in a higher interest rate. Ask your lender if this is an option and consider if it is worth the higher interest rate.
2) Are you eligible for refinance?Your lender will look at your current financial situation and credit history as well as your income to debt ratio. If you have poor credit history or significant unmanaged debt, it may be difficult to do better than your current rate. Creditors will also take into account the current value of your property and the amount of equity you have in your home (equity is the difference between your property’s current value and the amount you still owe on your mortgage).Most lenders require borrowers to have at least 5% equity in their home before they are eligible to refinance.
3) Does your current mortgage have a prepayment penalty? Some mortgages may include this penalty which is usually a percentage of your outstanding principal balance. Be sure to consider the cost of this penalty in weighing your options.
What is your reason for refinancing?
1) To lower your interest rate and/or your monthly payment.Lower payments could justify the refinance costs, but only if you stay in your home long enough to recoup them. If this is your primary goal, you can use a simple calculation to determine if this makes sense: Divide your total costs of refinancing including any fees by the total monthly savings you would achieve by refinancing. This will give you the approximate number of months it would take to recoup your costs of refinancing. If this is longer than you plan to stay in your home, it probably does not make sense to refinance.
2) To build equity faster.You may want to refinance to decrease the term of your mortgage, thereby building equity faster since more of your monthly payment will go towards the principal. Remember that this will likely increase your monthly payment.
3) To convert from an adjustable rate mortgage to a fixed rate mortgage.Many adjustable rate mortgages have low introductory rates that increase after the initial 3-5 years. Do you have an introductory rate that will soon increase? Do you have an interest-only loan and your payment will soon increase to include principal? If the answer to either of these questions is yes, it may make sense to refinance to a fixed rate mortgage.
4) To borrow from equity to free up extra cash.People who have significant equity in their home may use this option to pay for large expenses or consolidate debt since mortgage rates are generally lower than credit card rates. Remember that this option will increase your monthly payments and may have fees or tax consequences associated. This option should be considered very carefully and should only be done if it makes financial sense in the long term.
Clearly, the decision to refinance can be rather complex. There are a variety of online refinance calculators you may find helpful once you determine all the costs associated. As long as you do your research and consider what you want to get out of refinancing, you will know if you are making the right financial decision.
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