With low, low interest rates, refinancing is all the rage these days. But how do you know if refinancing is right for you? Ultimately, refinancing can save you money, whether in the long term or short term, so lets take a look at a few issues that you'll eventually have to consider when thinking about refinancing.
What are You Trying to Accomplish?
To set the record straight, refinancing only restructures your debt, it does not pay any of your debt off. So to keep things in perspective, refinancing your loan is synonomous with restructuring your loan. Here are the three main reasons one might choose to refinance their loan.
Lower Interest Rates: There are two ways to save money in the form of reduced mortgage payments by taking advantage of lower interest rates. One is refinancing your current loan with the lower interest rate, but keeping the remaining loan term constant. For example, say you have 25 years remaining on a $175,000 mortgage at 8%. Today, you could refinance the $175,000 mortgage at 4.5% for the remaining 25 years and save a chunk of cash on your monthly mortgage payment. Secondly, you can refinance your current loan at a lower interest rate AND re-extend your mortgage term. For example, say you have 23 years remaining on a $165,000 mortgage at 7%. You could refinance this loan at 4.5% and re-extend the loan back out to a 30 year term. This would free up more cash on your monthly mortgage payment than the previous example in the near term, but would add another 7 years to your loan and interest payback.
Debt Consolidation: Another common reason to refinance is to consolidate one or more loans to make them easier to manage. An example of debt consolidation is combining your first mortgage with a home equity loan. This combines the payments and consolidates your debt at a low managable payment over a fixed term.
Loan Restructuring: During times of very high interest rates, the difference between a fixed rate mortgage's rates and an adjustable rate mortgage's (ARM) rates can be substantial. However, during times of low interest rates, these differences are often too small to make much of a difference. One way of refinancing your mortgage would be to change from an ARM to a fixed mortgage rate, or vice versa. For example, in times of high interest rates, one might refinance their 11% fixed interest rate into a 8% ARM to reduce monthly payments. Conversely, during times of low interest rates, one might refinance their 4% ARM to a secure, relatively low fixed rate of 4.5%. Adjustible rate mortgages might seem very attractive, but remember, they do adjust. It pays to be on top of rates when using an ARM. Lastly, one unique way to save money in the long term would be to change your fixed financing terms from a 30 year fixed rate, to a 15 year fixed rate. This will effectively increase your monthly payment, but you will save 15 years of interest and mortgage payments, which will substantially benefit you in the long term.
When to Refinance
When looking to refinance there are a few things to consider. First, consider if your mortgage has any pre-payment penalties. Some do and some don't. You could wind up costing yourself more money if you aren't aware of these penalties. Secondly, you need to recoup the closing costs with your decreased monthly payments. If your closing costs would be $3000 and mortgage savings would be $150 per month, you would need to own your home for at least the next 20 months to benefit from the refinancing. Any lender or mortgage broker will be able to help you identify your anticipated closing costs from a loan. Lastly, as a rule of thumb, when current mortgage rates fall about 1% lower than your mortgage rate, that could be a time to start thinking about refinancing your rate.
I'll leave you with a few great resources if you have questions about mortages and refinancing:
American Capital Financial http://www.amcapfin.com/ 303.831.9636 -- I have a working relationship with DJ Davenport and Chris Coates, both are very knowlegable mortgage brokers and are very helpful to you when considering refinancing. Give them a call to discuss the options available to you.