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Is It Time to Refinance Your Mortgage? - Top 5 Criteria

As mortgage loan rates hover around historic lows, almost everyone seems to be asking themselves if they should refinance. And if you aren't, you should be. Your home is usually one of your biggest expenses and the source of a significant portion of your net worth. That's why it makes sense to consider all the angles before you make that important decision. Below are the top 5 things you need to think about.

  1. Interest Rates - Duh. That's what got you thinking about this topic in the first place. There used to be a rule of thumb that interest rates needed to drop 1-2% before refinancing made sense. I don't think that's the case anymore (if it ever was) because everyone's situation is different. Use an online mortgage calculator to run a couple of scenarios to see what different payments would be. Would it ever make sense to refi at the same interest rate or even on slightly higher? It might - see #2.
  2. Value of your Home - In 2008 when rates started dropping, many people couldn't take advantage of them because the value of their home dropped too. Even if you started with 20% equity and your home value dropped 30%, you were screwed. Eventually, government programs like HARP brought some relief, and now home values are on the rise again in most areas. If you put 10% down a few years ago, and have been paying PMI, you might want to see if the value of your home has risen enough to refi and get rid of that portion of your payment. That's when even the same interest rate will save you money. But think about #3.
  3. Loan Term - The length of the new mortgage is important when you refi. Although a drop in interest rate does cause your payment to go down, what most people don't realize is that if you refi back into the same term you originally had, you might not be better off long term.   For example, say your original mortgage was for $250,000 at 3.5% on a 30-year fixed. Your P&I payment was $1123. Three years later, you can refinance to a new 30-year mortgage at 3.0%, and the new loan amount is $235,000 because you've paid off $15k during those 3 years. Your new payment is $991 and you start jumping up and down for joy. You're saving $132 bucks a month! Well yes, for those first 27 years. Then for 3 years you're paying $991 a month that you wouldn't have had to pay had you stayed in your original mortgage!!! If you do the math, you are still saving, but it isn't nearly as much as you thought. And tack on closing costs...see #4.
  4. Closing Costs - Many times when you refi, your mortgage guy either offers to "pick up the closing costs", or they "get rolled into the loan". When he says he'll pick up the closing costs, that means you aren't getting the best rate you could have gotten (i.e. you would get something like 3.125% in our example above), than if you had paid your closing costs out of pocket. When they get rolled into the loan (you borrow more than the $235,000 in our above example), that means you are paying interest on them for 30 years. Those closing costs end up costing you a lot more. If you actually pay closing costs, then you have to think about how long you are going to be in the house and how many months of savings of the $132 it takes to break even. Also you probably want to shop around with several lenders and/or brokers and see who can give you the best deal - costs can be wildly different.
  5. Your Personal Situation - In the end, your personal situation may be what tips the decision one way or the other. Has your credit improved or gotten worse and do you have more or less debt than you did before? That will affect whether or not you can get the best rate. Are you looking to just lower your monthly payment, get rid of PMI, or pay your mortgage off faster with less interest paid over time. Do you plan to move in the next couple of years? Do you want to go through the hassle of refinancing? Not to make your head explode, but do you want to consider a cash-out refi so you can do some remodeling, or pay off high-interest debt? 

The refinance decision almost always involves several moving parts and non-numerical considerations. Think through the five criteria above and you'll be well on your way to making a smart decision. If you need assistance, feel free to reach out!