When’s the best time to refinance your home? When you can take advantage of lower interest rates, get out of an ARM, add value to your home, and save more money.
Should I refinance my home?
If you’re going to keep or stay in your house for the foreseeable future, refinancing your home may be an ideal way to save money every month, lower your mortgage, and even add value to your property.
Though you can technically refinance your home as many times as you’d like, you’ll have to pay closing costs with your new mortgage and possibly even refi fees each time.
These potential downsides may be worth it if they mean you’ll shrink your monthly payments or get to upgrade that bathroom you’ve always hated.
You Might Want to Refinance Your Home If You Can…
Every time you make your monthly mortgage payment on time and in full, you chip away at the principal of your home loan, or the amount you borrowed to purchase your house, and build equity.
Equity is the number you get when you subtract the balance of your mortgage from your home’s current market value, or what it would sell for today.
Home values depend on lots of uncontrollable factors like market conditions, the supply/demand of homes in your neighborhood, and so on. These can either raise or lower the value of your home, and so affect your equity.
When you finally have enough, your equity may allow you to refinance your home.
But you should only refinance your home when you can:
Lower Your Interest Rate
The number one reason homeowners refinance their home is to score a lower interest rate for their mortgage.
Securing a lower interest rate will not just lower your monthly payment, but also decrease how much you’ll pay in overall interest for the term (or duration) of your mortgage.
If mortgage rates were high when you first purchased your house, you may be able to take advantage of lower rates now.
Just check out how rates for 30-year fixed mortgages have changed in the last five, 10, and almost 20 years[*]:
- 2000: 8.05%
- 2008: 6.03%
- 2013: 3.98%
- 2018: ~4.46%
That’s a huge difference in interest!
If you bought your house in 2000, you may be able to shrink your mortgage rate by almost half with today’s rates.
And that could save you hundreds in the short-term and thousands over your lifetime of owning your home.
Market rates aren’t the only numbers to watch. Your own financial adulting skills may also play a role in lower mortgage payments.
Qualify for a Better Mortgage Rate
If your modest starter home was the first major purchase of your adult life and you’ve been climbing the corporate ladder ever since, your financial situation may be much better than what it was back then.
During a home refinance, you’ll have to go through the lending process all over again. But your awesome years adulting may help you qualify for a lower interest rate.
So for example, you may be considered for a lower mortgage rate if you:
- Raised your credit score
- Earn a higher salary
- Got married (and merged household income)
These milestones all show you’re fiscally trustworthy and may unlock lower interest rates you did not have access to back when you first bought your home.
You may also have chosen an adjustable-rate mortgage and now you want to switch to a lower, fixed rate, which a refi can accomplish as well.
Switch from an Adjustable-Rate Mortgage to a Fixed-Rate Mortgage
An adjustable-rate mortgage (ARM) is ideal if you’re not buying your forever home.
ARMs offer a fixed interest rate that’s typically lower than those for 30-year mortgages for the beginning of your loan, which is usually between three and 10 years.
So if you’re constantly relocating for work, know you’re going to buy a bigger house as your family grows, or plan to retire elsewhere soon, this low interest rate will help you save money.
But when this honeymoon period of your loan ends, your interest rate will adjust periodically based on your loan terms and the current interest rate index used by your lender.
That means you will not have steady mortgage payments and may wind up paying more or less each month based on the market.
That’s why many homeowners choose to refinance out of an ARM and into a fixed-rate mortgage before these fluctuating interest rates begin.
Your interest rate will never change with a fixed-rate loan. Once you agree to the interest rate, you’ll pay that for the life of your mortgage.
So if you have an ARM currently, you can enjoy the perks of a lower interest rate in the beginning and lock in a new fixed-rate loan for a 10-, 15-, 20-, or 30-year term with a refi.
Though it’s ultra tempting to go with the low monthly payments offered by that 30-year mortgage, the longer your term, the more you’ll pay in overall interest.
In addition to lowering your interest, a home refinance may also help you get rid of PMI too.
Slash Your Private Mortgage Insurance (PMI) Premiums
If you bought your home with less than 20% down, you’re probably paying private mortgage insurance (PMI).
PMI protects your mortgage lender from losing lots of money if you decide to default on your loan and stop making payments.
Annual premiums for PMI range from 0.5% to up to 5% of your mortgage.
Loans insured by the Federal Housing Administration (FHA) require PMI for the entire term of your mortgage.
But as long as you have over 20% equity built up in your home, or your loan balance drops below 80% of your home’s value, you can refinance out of an FHA loan and into a conventional loan without PMI.
And the same is true for refinancing from a conventional loan with PMI to another conventional loan without PMI.
So not only will you lower your interest rate with a new loan, you’ll be able to pocket the cash you’ve been spending protecting your lender now too.
But if it’s extra cash you really need, a cash-out refinance may be the best route — although it works a little differently.
Opt For a Cash-Out Refinance
Paying down your loan while your home gains value builds equity the fastest.
When your equity is high enough, you may be able to borrow against the value of your home with a cash-out refinance.
A conventional refi will replace your current mortgage with one for the same balance. So if you have $100,000 left on your mortgage, that’s how much your new loan will be for.
A cash-out refinance gives you a new mortgage for an amount higher than what you currently owe on your house. Then the difference between the amount you owe and the loan amount will be given to you in cash.
So if your home is worth $300,000 and your mortgage balance sits at $150,000, you have $150,000 of equity.
With a low interest cash-out refi, you may be able to secure a new mortgage for $200,000.
Using this example, you subtract the mortgage balance from the amount of the new loan, which in this case is $200,000 minus $150,000, and you’ll have $50,000 in cash.
This extra money isn’t for extravagant vacations or shopping sprees.
It’s best used to earn a return on your money, such as:
- Making home improvements to raise the value of your home (and your equity)
- Paying off debt to raise your credit score (and help you qualify for lower interest rates)
Just remember, you can’t take out more than 80-90% of your home’s equity with a cash-out refinance.
And as another heads up: a cash-out refinance may carry slightly higher interest rates than other refis, but that’s because the loan is also much larger.
A cash-out refinance is the most risky because your home is literally the collateral backing your loan. If you don’t make your payments on time and in full, you could risk losing the home you love.
So Should You Refinance Your Home?
Since closing costs are usually 2–6% of your mortgage, you should expect to pay between $6,000 and $18,000 for a $300,000 loan. You may also face refinance fees too.
Should I refinance my home? Only if you’ll save more money with a home refinance than you’ll pay in closing costs and fees.
To crunch the numbers yourself:
- Determine how much you still owe on your mortgage.
- Learn your home’s current market value.
- Check out mortgage rates from the best lenders.
- Compare the loan terms, projected monthly payments, and refi fees in addition to closing costs to weigh the financial reward.
A home refi may help you lower your mortgage payment so you can start saving for other important expenses like college tuition, funding your dream retirement, or paying off your credit card debt.
So do your homework and see if you can take advantage of one now.