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Turn a good mortgage into a great deal
Jeanne Lee
Jeanne Lee is a freelance business and personal finance writer living in Brooklyn with her husband and son. Her work appears in Fortune, Money and Fortune Small Business, among other publications.
Gone are the days when you stuck with one mortgage for 30 years and paid it off just in time for retirement. If refinancing rates are anything to judge by, today's homeowners are continually on the lookout for a better deal on their home loans. Americans refinance every four years on average, according to the Mortgage Bankers Association.
"Today's homeowners are continually on the lookout for a better deal on their home loans, refinancing every four years on average."
Refinancing means renegotiating the terms of your loan, whether to lower the interest rate, change the repayment period, increase the amount of the loan, or switch to an adjustable-rate loan from a fixed, or vice versa. A new mortgage pays off the old one, and you begin making payments based on your new payment schedule and terms.
The simplest reason to refinance is to switch to a loan with a lower interest rate. Say you borrowed money to purchase your house at an interest rate of seven percent for a 30-year fixed-rate loan, and today's going rate is six-and-a-half percent. If you refinance, you'll have a lower interest rate over the life of your loan. However, that doesn't mean you'll necessarily save money in the deal, either over the long term or in your monthly payment. There's more to it than that. Refinancing costs money, and you may be charged for appraisal, origination, and insurance fees, plus title search and legal costs — all of which can add up to thousands of dollars. You may want to consider this rule of thumb: refinance if you can lower your rate by at least one percentage point.
But every case is different. For today's sophisticated consumers, there are many different scenarios in which refinancing makes sense, depending on your individual financial goals. If your income has increased and your priority is to get out of debt as soon as possible, you can refinance to a loan with a shorter repayment period — such as replacing a 30-year note with a 15-year note — which typically offers lower interest rates. To finance a major expenditure such as a home renovation, college tuition, or a new car, homeowners with significant equity in their house might opt for a "cash-out" refinancing, in which you increase the amount of principal you owe on your loan. If you're strapped for cash in the short term, you may lower your monthly payments by switching to a different type of mortgage (from a fixed to an adjustable-rate mortgage, for example) or by extending your repayment period, although these options may increase your total interest costs.
An important consideration is how long you intend to stay in your home. If you think you might move in a year or two, the transaction costs may outweigh potential savings you'd realize in such a short time frame. Another factor is whether there is a prepayment penalty on your current mortgage. When weighing the refinancing costs, you need to figure how long it will take to reach the break-even point, when your cost savings balance out the up-front fees associated with refinancing. For example, if your new monthly payment is $200 less per month, but you have to pay $5,000 in transaction costs, it will take you a little over two years to start saving money. To get a more precise estimate, enter the terms of the new mortgage into an online refinancing calculator that allows you to see whether it saves you money compared with your current deal.
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