Scenario : Converting From An Adjustable
Adjustable-rate mortgages can be an alluring option for home buyers because you can secure a lower introductory rate during the early years of owning your house. In exchange, your loans rate has the potential to increase after that initial period. If interest rates have gone up since purchasing your home, youre likely looking at a higher rate when your ARM adjusts putting an unexpected strain on your budget.
Our take: If interest rates start to inch upward, you may want to consider refinancing your ARM to a fixed-rate mortgage, which will offer consistent monthly payments. But if rates continue to fall, the periodic rate adjustments on an ARM mean decreasing rates and smaller monthly mortgage payments eliminating the need to refinance to take advantage of a rate drop.
Related: 8 Steps to Refinance Your Mortgage
How To Decide Whether Closing Costs Are Worth It
Whatever the fees may be for your particular mortgage refinance, it’s important to compare the costs with the benefits.
As one example, let’s say you’re refinancing a $300,000 mortgage with a 30-year term and a 4.25% interest rate. The new loan rate is 3.25%, and you’re keeping the same repayment period that you have now.
In this instance, the refinance reduces your monthly principal-and-interest payment from $1,476 to $1,306, a monthly savings of $170. Now, if the closing costs on the refinance total $9,000, it will take you roughly 53 months, or almost four and a half years, to break even with the monthly savings.
If you’re planning on staying in your home longer than that and don’t anticipate refinancing again during that period, it’s worth it. But if you think you’ll sell the house before you reach that break-even point, the costs outweigh the savings.
Doing a cost-benefit analysis on other mortgage refinance purposes can be more challenging because there isn’t necessarily a clear way to compare what you’ll get with what it’ll cost you. But it’s still a good idea to consider both the benefits and drawbacks.
It’s also important to note that you can often roll the closing costs into your new loan. While this saves you money upfront, it can cost you more in the long run because you’re now paying interest on closing costs in addition to the principal loan amount.
Mortgage Rates Have Gone Down
Mortgage rates can fluctuate since theyre impacted by a variety of factors, including U.S. Federal Reserve monetary policy, market movements, inflation, the economy and global factors.
If mortgage rates fall, you may be able to save by securing a lower interest rate than you have on your existing loan.
So how much should mortgage rates fall before you consider refinancing? The traditional rule of thumb says to refinance if your rate is 1% to 2% below your current rate.
Make sure to factor in your current loan term when considering refinance though. For instance, if youre four years into a 30-year mortgage and refinance to a new 30-year term, it will have taken you 34 years total to pay off your home in the end. Plus, youll likely pay more interest over the extended term than if you had chosen a shorter term.
No matter what rates are doing, youll want to check that the math works out in your favor.
Make sure to calculate your break-even point and how the overall costs including total interest of your current mortgage and your new mortgage would compare, says Andy Taylor, general manager for Home/Mortgage at Credit Karma.
Use our refinance calculator to determine if refinancing your mortgage is financially worth it.
% Refinancing Rule Of Thumb Vs Break
Although the 1% refinancing rule of thumb is a good guide, you should weigh it against the break-even point rule of thumb. This rule of thumb is based on how long it will take you to break even on the refinancing, based upon the closing costs and savings, Cohn explained. Its the point at which youll actually start saving money after paying off your refinancing fees. Thats why you need to consider how long you plan to stay in the home as part of your refinancing decision.
Lets go back to our example above about refinancing a $200,000 mortgage from 6% to 5%. Youd save $125 a month, which works out to $90 after taxes. However, lets say the fees and closing costs for your new mortgage amount to $2,500. If you divide your costs by the monthly savings , it would take you 28 months to break even. If you dont plan on staying in the house that long, it may not be worth it to refinance your mortgage.
Should You Refinance For 05%
You may be able to consider a refinance for 0.5% in certain situations. If you keep the new loan long enough to bounce back from the closing costs or if you can persuade the lender to take care of your closing costs you may be able to consider this mortgage rate as a viable option. It is important to keep in mind that when you refinance for just a 0.5% rate you get less savings compared to refinancing at a higher rate. That means it will take more time to recover from the closing costs of the refinance.
It is best to see this in numbers. For example, dropping your rate from 3.75% to 3.25% could save you $150 per month on a $300,000 home loan, according to Mortgage Reports.
While that savings may sound nice it will take a little over three years to reach your break even point when you account for closing costs. Which means the refinance will only be worth it if you stay in the home for at least 4 years. Now compare that to a refinance for 1%.
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The Pros And Cons Of Refinancing
|Pros of refinancing||Cons of refinancing|
|Access the equity youve built up in your home.||Increasing the amount you are borrowing may lengthen the time it takes to pay off your mortgage.|
|Consolidate your debts and lower your overall interest rate.||Your overall interest rate might be lower but the amount owing on your mortgage may be higher.|
|Possibly get a lower interest rate and pay less for your mortgage over time.||There may be additional costs, including a prepayment charge.|
You Want To Do Home Improvements Or Renovations
From fixing a broken HVAC system to replacing the pink linoleum in the bathroom, you might need to invest in your home at some point or another. Using the equity in your home can be better than taking out a personal loan or putting charges on a credit card because cash-out refinances usually have lower interest rates than most credit cards.
Cash-Out Refinance For Renovations
The average 30-year mortgage rate is currently under 4% and the average low-interest credit card rate is more than 12%. If you choose a variable rate credit card or a store credit card, youll likely pay even more in interest. If you have enough equity in your home to do a cash-out refinance, you can complete your renovations or repairs without excessive interest charges.
Though you can do anything you want with the money you get from a cash-out refinance, its important to remember that your refinance is still a loan. Its a good idea to get estimates from contractors or repair professionals before you close on your refinance. This will lessen the chance that you take out too much money or you take out too little and have another bill after the job is finished.
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Extend Or Reduce The Amortization Period
Amortization, or the length of time it will take you to pay off your mortgage, is another thing homeowners in the GTA should consider. A familys financial situation may have changed since getting the first mortgage and it might just make sense to refinance with a shorter or longer amortization period.
If you find your finances have improved, it might be a good idea to refinance a mortgage with a shorter amortization period. Increasing mortgage payments can lower the amortization period by five or more years and save tens of thousands in interest payments.
Its also quite possible that the family budget has been stretched thin and you want to free up some capital. In this case, refinancing a mortgage with a longer amortization period might be the best thing to do. It will take longer to pay off the mortgage and lead to more interest payments, but it could free up $100.00, $200.00, $300.00, or more a month.
Refinancing To Secure A Lower Interest Rate
One of the best reasons to refinance is to lower the interest rate on your existing loan. Historically, the rule of thumb is that refinancing is a good idea if you can reduce your interest rate by at least 2%. However, many lenders say 1% savings is enough of an incentive to refinance.
Reducing your interest rate not only helps you save money, but it also increases the rate at which you build equity in your home, and it can decrease the size of your monthly payment. For example, a 30-year fixed-rate mortgage with an interest rate of 5.5% on a $100,000 home has a principal and interest payment of $568. That same loan at 4.1% reduces your payment to $477.
Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development .
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How Long You Plan To Stay In Your Home And Why It Matters
When considering whether to refinance your mortgage, also consider how long you plan to stay in your home. The length of time you intend to own a piece of property can impact whether refinancing is worth the expense.
For example, if you only anticipate owning the home for a few more years, you likely wont save enough on mortgage payments to justify the added costs of refinancing. Alternatively, it may make more sense to refinance your forever home because youll have longer to recoup the cost of refinancing.
What Is An Origination Charge
The origination charge is the amount charged for services performed on the initial loan application and loan processing. This includes all charges that lenders and brokers involved in the transaction will receive for originating the loan. It includes any fees for application, processing, underwriting services, and payments from the lender for origination. Learn more about closing costs.
If you are a service member on active duty, prior to seeking a refinance of your existing mortgage loan, please consult with your legal advisor regarding the relief you may be eligible for under the Servicemembers Civil Relief Act or applicable state law.
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When Is It Worth Refinancing
Mortgage refinancing is a great way to save money. But this is not always a good move for every homeowner.
People refinance for a variety of reasons, including getting a lower interest rate, changing their monthly payment amount and reducing their interest cost. In general, refinancing is the best course of action if you reduce your interest rate by at least 0.75%.
Heres an example of how refinancing can save you money: If you refinance your 30-year, $ 300,000 loan with a 3.25% interest rate at 4%, you reduce your monthly payment from $ 1,432 to $ 1,306. Thats a monthly savings of $ 126, which adds up to $ 45,360 in mortgage life.
But before you refinance, be sure to weigh the closing costs and calculate how long it will take before refinancing your savings to cover refinancing costs.
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Super: TD presents Asking for a FriendWhy Would You Refinance?
Welcome to Asking for a Friend. Lets see who could use some financial advice today.
Dear Asking for a Friend,My neighbour was talking about refinancing her home so she can borrow more money to build an extension, and it got me wondering…what exactly IS refinancing and why do people refinance?Sincerely,Next Door Nancy
I hear you, Nancy. First, what is refinancing?
Refinancing means renegotiating your existing mortgage loan agreement, usually to use any available equity in your home.
So what does that mean in real terms? Let’s say the value of your home is $500,000.
80% of home value 0.8 x $500,000 $400,000Outstanding balance of your mortgage $300,000How much you can borrow $100,000
Subject to the bank’s approval, you could borrow up to 80% of the value of your home less the outstanding balance of your mortgage.
That means if your home is worth $500,000 and you have an outstanding balance of $300,000 on your mortgage, you may be able to borrow an additional $100,000 .
So WHY do people refinance?
Super: To consolidate debts.
Super: Provide flexibility to pay for big ticket items.
Book an appointment and get financial advice for what you feel is most essential, through TD Ready Advice
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Add A Home Equity Line Of Credit
A home equity line of credit gives you access to the equity in your home, at your own discretion. A HELOC works a lot like a credit card account, but because its a secured loan the interest rates are much lower. If you do take money from it, youll be responsible for monthly interest-only payments on the outstanding balance. You can access a home equity line of credit through your existing lender and a small subset of other lenders.
What Are Your Other Financial Goals
You don’t want to spend the time, effort and money it takes to refinance just to lose those savings to lifestyle inflation. Think through exactly how you plan to use your newfound savings.
It’s important to look at all financial decisions from the bigger lens of what matters most to you in life. What are you aiming for?Scott Frankcertified financial planner
“It’s important to look at all financial decisions from the wider lens of what matters most to you in life. What are you aiming for?” Frank says. “And then anytime you can optimize cash flow, you need to always be thinking about, ‘Where can I put this to help with me with a better life?'”
It’s smart to check in on your other priorities. “When you are considering a change to your monthly bills, it’s a good time to take a moment and consider your progress on other goals, such as saving for education, retirement or a wedding,” Pearson says.
While refinancing could be a way to save money in the long-term, it’s not worth it if the upfront costs put you in a financial hole. “Ask yourself if you have three to six months’ worth of savings in the bank to cover things like a job loss, unexpected home repair or next year’s vacation before you consider paying additional fees today,” Pearson adds.
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How Does Mortgage Refinancing Work
When you refinance, your current loan gets paid off and replaced by a new one with different terms. In the transaction, several things about your loan could change, including your interest rate, the length of your loan, the loan balance itself and even the type of loan you have.
When youre refinancing, the loans break down into the following two categories. Which path you take depends on what you want to accomplish through the refinancing process.
Scenario : Reducing The Total Cost Of Your Monthly Mortgage Payment
Refinancing to lower your interest rate can shrink your mortgage bill. But its not always possible to improve your rate. If a better interest rate isnt an option, you can reduce your monthly costs by refinancing to a mortgage with a longer term than the repayment period thats left on your current loan.
Our take: Theres a trade-off when refinancing to a longer loan term. Since youre increasing your repayment period, youll pay more in interest over the life of your loan. But your monthly costs become more manageable, so it could be worth it if your budget is tight.
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Refinancing To Shorten The Loan’s Term
When interest rates fall, homeowners sometimes have the opportunity to refinance an existing loan for another loan that, without much change in the monthly payment, has a significantly shorter term.
For a 30-year fixed-rate mortgage on a $100,000 home, refinancing from 9% to 5.5% can cut the term in half to 15 years with only a slight change in the monthly payment from $805 to $817. However, if you’re already at 5.5% for 30 years , getting, a 3.5% mortgage for 15 years would raise your payment to $715. So do the math and see what works.
Ok So Should I Refinance
To see if refinancing makes sense for you, try out a refinance calculator. You enter some specific information and the refinance calculator determines what makes the most sense for your particular situation. Then you can even play around a little bit to see what factors would change the recommendations.
The main number you are looking out for is the point when the monthly savings of the new mortgage become greater than the up-front costs of refinancing. In other words, how long will it take you to recoup the fees you paid to do the refinance? If that number is within the timeframe you plan on staying in the house, you may want to refinance. If you’re planning on selling in the near future, refinancing might not be worth it.
A good refinance calculator will show you the two scenarios keeping your current mortgage and getting a new one. Then you can see how your monthly payment will be affected and how much you can expect to pay in closing costs. This also shows that very important timeframe for how long you have to maintain the new mortgage to save enough money to cover the up-front costs. Basically, this is the point when you start actually saving money.
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