Change Your Loan Type
In some cases, you may want to refinance to convert to a fixed- or adjustable-rate mortgage . For example, ARMs usually start out with a lower rate than a fixed-rate mortgage and, through periodic adjustments, can leave you with a rate that’s higher. In this situation, it may make sense to change to a fixed-rate mortgage that would protect you against future interest rate increases.
There are also situations where it might make sense to change to an ARM. For example, if interest rates are falling, the periodic rate adjustments can result in reduced rates and smaller mortgage payments. This might be something to consider if you plan on staying in your home for a term less than the initial ARM adjustment period.
To Take Advantage Of A No
A “no-cost” mortgage loan does not exist, so be careful when you see such an offer. There are several ways to pay for closing costs and fees when refinancing, but in every case, the fees are paid in one way or another. In other words, homeowners can pay cash from their bank account for a refinance, or they can wrap the costs into their loan and increase the size of their principal.
Another option is for the lender to pay the costs by charging a slightly higher interest rate or including closing points. You can calculate the best way for you to pay the costs by comparing the monthly payments and loan terms for each scenario before choosing the loan that works best for your finances.
How To Calculate Refinance Savings
To calculate the value of refinancing your home, compare the monthly payment of your current loan to the proposed payment on the new loan. Then use anamortization scheduleto compare the principal balance on your proposed loan after making the same number of payments youve currently made on your existing loan. Both the monthly payment and principal balance of the new loan should be lower. Enter your specific details into therefinance calculator above for a detailed savings breakdown.
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You Want To Convert From An Adjustable Rate To Fixed
If mortgage rates are increasing and you currently have an ARM or adjustable rate mortgage you may want to consider refinancing and converting to a fixed-rate mortgage. Thats because with an ARM, your rate may increase beyond what youd pay with a fixed-rate mortgage. If youre concerned over future interest rate hikes, a fixed-rate mortgage could provide some peace of mind.
Refinancing To A Shorter Term
On the other hand, refinancing into a shorter-term mortgage can be an unequivocal win.
Interest rates are lower on 15-year loans compared with 30-year loans. In that same example, if you instead refinanced into a 15-year mortgage with a 3% interest rate, youd save a whopping $94,000 in interest compared to sticking with the original loan. Plus, you would be free from mortgage payments seven years earlier.
The tradeoff is that youll pay roughly $250 a month more compared to keeping the original loan.
|Years left to pay|
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How Long Does It Take To Recoup The Costs Of Refinancing
The interest rate is not the only cost to weigh when youre considering whether refinancing is worth it. There are costs to close the new loan, and they can be steep. Expect closing costs to total 2 percent to 5 percent of the principal amount of the loan. If you borrow $250,000 and closing costs are 4 percent, for example, you would owe $10,000 at closing.
Rather than require all that money upfront, many lenders let you roll the closing costs into your principal balance and finance them as part of the loan. Keep in mind, though, that adding those costs to the loan only increases the total amount that will accrue interest, ultimately costing you more.
How Much Will It Cost
Homeowners are often eager to request a refinance until they see what it will cost them.
Remember all those fees and closing costs you paid when you first bought your house? Prepare to pay most of them again. Broker fees will vary, but a typical refinance will cost anywhere between 3-6% of the loans principal.
Before proceeding with your refinance, make sure youll actually be saving money. You can do this by procuring a good faith estimate from several lenders. This will get you your projected interest rate and the anticipated loan price. Next, divide this price by the amount youll save each month with your anticipated new rate. This will give you the number of months that will have to pass before you break even from the new loan.
If you dont plan on staying in your home for that long, or you cant afford to wait until then to recoup your losses, refinancing may not make sense for you.
Extra Money To Invest Elsewhere
Depending on your level of investing savvy and confidence in your investing abilities, you may believe that you can earn more money investing than you’re paying in interest. For example, if you believe you can earn a 7 percent rate of return on your investments and you can refinance down to a 4 percent interest rate, the 3 percent spread represents profit for you if you use the money you aren’t using to pay the mortgage for investments. In addition, your mortgage interest and home equity interest is tax-deductible, so Uncle Sam may end up giving you a tax break on the interest you pay on your mortgage.
Why Would Refinancing Be A Bad Idea
Refinancing is a bad idea if it doesnt represent some sort of gain, be it in the form of lower monthly payments or saving on interest by reducing the term of your loan. If the interest rate being offered isnt at least 0.5% lower than your current rate, its probably not worth the cost of a refi. Another reason not to refinance is if you plan on selling the house before you reach your breakeven point or if the new monthly payment is more than you can comfortably afford.
What Credit Score Is Needed To Refinance
Borrowers with credit scores of 620 or greater may be eligible to refinance their home, but credit scores of 740 or higher receive the most favorable refinance interest rates. The higher your credit score the lower your refinance interest rate, so it’s beneficial to have a healthy credit score.Calculate your estimated savings at varying interest rates to see if it’s worthwhile to wait and improve your credit score before refinancing.
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Will You Stay In Your Home Long Enough To Benefit From A Refi
Using our example , youd pay $23,000 in interest over the next three years with your current 30-year loan at a 4% interest rate.
On the flip side, the 15-year refi at 3% interest would only cost you about $17,000 in interest the first three years. That means, after three years, your refi will have made up for its own closing costs .
After that, youll enjoy thousands of dollars of savings nearly every year until you pay off the mortgage or sell your home! But if you relocate in just 12 years after refinancing, you wouldnt earn back that $6,000 and the refi wouldnt have been worth it.
Whewthats a lot to throw at you! And we know that even when using a mortgage calculator, the math can be pretty complicated. So ask a home loan specialist you can trust for helplike our friends at Churchill Mortgage.
Prepay Your Mortgage Instead Of Refinancing
For many homeowners, the higher monthly cost of a shorter loan term isnt in the budget.
This is why some homeowners skip the refinance and opt to prepay their mortgage instead. You dont get access to new, lower rates, but you take better control of your loan.
Prepaying your mortgage means to send extra payments to your lender each month, which chips away at the amount you owe faster than your amortization schedule prescribes.
- If your mortgage payment is $1,750 per month
- And you send $2,000 to your lender each month instead
- You reduce the amount owed on your loan by $250 every month. This will cause your loan to reach its end date sooner
The more you prepay, the more money youll save.
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What To Know About Refinancing Your Mortgageand If Its Right For You
If youve noticed lower interest rates lately, you might be tempted to refinance. Lower interest rates are appealing and can lower your monthly paymentsbut thats not the only factor to consider.
is just as financially important as arranging to buy a home. With a refinance, youre replacing your old mortgage with a new loan, so its essential to be on top of the situation.
Refinancing is best evaluated on a case-by-case basis. Well give you the facts about the pros and cons of refinancing so you can make the right choice for your home .
Refinancing Your Mortgage Can Be A Smart Financial Move Potentially Saving You Money On Your Monthly Mortgage Payment Or On Total Interest Over The Life Of Your Home Loan
Before you apply, youll want to think carefully about when to refinance your mortgage. Youll also want to decide if refinancing makes sense financially by weighing any money youll save against the cost of refinancing the loan.
Well review some common scenarios to think through.
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Can You Pay Off Your Mortgage Early
In most cases, homeowners can pay off their mortgage early, provided you follow certain ground rules and make sure the terms of your loan.
The first step is to recognize how your payment works. Early in a 30-year loan, the bulk of the payment goes toward loan interest. As the loan is closer to completion, the bulk goes toward the amount you borrowed, or the principal. But if the principal is lowered through extra early payments, the interest paid also is lowered. Paying down principal in the long run will reduce the total interest paid on the loan.
The more the principal is paid, the more the homeowner builds equity in the home. To easily figure the equity, calculate a fair price you feel the home is worth then subtract the loan balance. If a home could be sold for $300,000 and you have $150,000 left on the loan, you have $150,000 in equity.
When considering paying the mortgage early, be sure you know the answer to a question that many, especially first-time homebuyers, often do not consider: Is there a prepayment penalty on your loan? Many lenders do not have this penalty, but those that do will charge for making early payments. If you have any uncertainty, call your lender to ask specifically about prepayment penalty.
Once that question is answered, be sure to tell your lender if and when you make extra payments that you want that money applied to principal.
Your Homes Value Increased
Another reason to refinance your mortgage is if the value of your home has increased. This allows you to do whats called a cash-out refinance an especially valuable option if you have high-interest debt that you need to pay down.
For example, you may have purchased a $200,000 home and put a $40,000 down payment on it, leaving you with a $160,000 mortgage. Youve made regular interest payments and now owe $100,000. However, over the last several years, the value of your home has increased from $200,000 to $250,000. This means you can take out a mortgage for more than the remaining cost of your mortgage and pocket the difference. You can then use it for any needs, whether thats financing an addition to your house or paying down some high-interest credit card debt.
This can be a viable way to consolidate your debt. However, you should only do this if you can make the new regular payments on your mortgage. Your total debt will not decrease, but by paying off high-interest debt you can save money by paying less total interest.
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How To Calculate The Break
The break-even point on a mortgage refinance occurs when savings equals costs, explains Jared Maxwell, vice president of consumer direct lending at Embrace Home Loans.
To determine the break-even point on your refinance, divide the closing costs by the amount youll save each month with your new payment.
Lets say that refinancing will save you $150 per month, and the closing costs on the new loan are $4,000:
$4,000/$150 = 26.6 months
So, if you were to close your new loan today, youd officially break even just over two years and two months from now. If you live in the home for an additional five years after that point, the savings really start to add up $9,000 total.
You can use Bankrates refinance break-even calculator to figure out how long it will take for the cost of a mortgage refinance to pay for itself. If you think you might sell the home before your break-even point, refinancing might not be worth it.
How Much You Could Save On Interest By Refinancing To A 15
If you refinance from a 30-year mortgage to a 15-year mortgage, your new monthly payment will most likely be higher, but the total interest youll pay over the life of the loan will be lower. Youll also own your home outright sooner.
Lets say youre four years into your 30-year mortgage, and you now want to refinance to a new 15-year mortgage. Your current balance is $231,724. Rates are low, and you manage to secure a great APR, dropping down from 4.15% to 2.20%.
While this will raise your monthly payment by about $300, youll stand to save over $106,000 in interest with the new loan.
Heres a breakdown of how much in interest you could save in this scenario by refinancing into a 15-year loan:
Even after paying $4,600 in closing costs to get the new loan about 2% of the loan amount youll come out way ahead in this example. Your breakeven period would be $4,600 divided by $300, or just over 15 months. So by month 16 of your new loan, youd be coming out ahead.
The choice to refinance wont always be so clear cut, and refinancing into a shorter loan term isnt right for everyone. But its worth at least doing the math to see what you could save.
For a more customized approach, use our mortgage payment calculator below to determine how much you could save on interest by switching from a 30-year loan to a 15-year loan.
Enter your loan information to calculate how much you could pay
Checking rates won’t affect your credit score
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What Are The Biggest Obstacles To Refinancing
Loss of income due to lack of work, a credit score that has dropped or is too low, and a high debt-to-income ratio can prevent you from refinancing.
Debt-to-income ratio is your total debts each month compared to your monthly income. An optimum debt-to-income ratio is below 36 percent, says McBride. That means that your debts including your monthly mortgage payment, monthly maintenance fees or common charges, taxes, property insurance, credit cards and vehicle loans should not exceed 36 percent of your gross pay.
Certain business owners can face difficulties getting refinancing. It can be harder to qualify for a mortgage if you have 1099 tax income from a sole proprietorship, for example, rather than W-2 income as an employee.
Yet you can have good credit without traditional sources of income, says Kan. There are credit models that reflect nontraditional incomes.
How Seasoned Is Your Loan
Refinancing doesn’t make sense if you’re losing your potential savings to additional interest costs. “If you are five years into a 30-year mortgage and you refinance into another 30-year mortgage, you are going back to the beginning and may pay more in total interest,” Baker says.
However, that doesn’t necessarily mean that you should refinance into a shorter term mortgage. “If a borrower isn’t too far into the loan term they may still end up paying less in interest if the rate is reduced enough,” Baker says. “Furthermore, most people don’t stay in their homes for a full 30 years often the full effect of the interest over the whole term isn’t realized.”
Scott Frank, a certified financial planner and founder of Stone Steps Financial, agrees that you shouldn’t automatically jump into a shorter term mortgage. They often come with higher monthly payments, and “most people are looking to refinance because it will reduce their monthly payment which will allow them to put those funds to work in another area of their life,” Frank tells CNBC Make It.
“If someone wants to pay off a loan faster, I prefer they get a 30-year fixed rate loan and pay it as though it is a 15-year loan,” Frank adds. On a deeply seasoned loan, refinancing might result in the borrower owing a significant amount in interest. But if you’re saving enough each month that you can increase your monthly principal payments to pay off the loan faster, you might be able to avoid the additional interest, he explains.
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