Have you been studying refinance rates but aren't sure if now is a good time for taking out a home loan? Deciding if refinancing is a good idea can be an intimidating decision for many homeowners as interest rates can be nearly impossible to predict. Here are several tips to help you decide if it's a good idea in your situation.
The Percent Rule of Refinancing
Many financial advisors quote the "rule" of refinancing as it's a good idea to refinance if rates are anywhere from half a percent to two percent lower than what you're currently paying. Truth be told there is no "general rule" as everyone's situation is different and what makes sense for one person might not work for you.
The problem with taking out a new mortgage is that every home loan comes with fees. Even those so-called "no fee" refinance offers come with some fees as does any other mortgage loan. The difference is that you're not paying them in exchange for higher refinance rates.
The fees that you can expect to encounter refinancing your home are very similar to the ones paid when you purchased your home. These include bank or lender fees, attorney fees, appraisal, and title fees. These charges can quickly add up to $3,000-$5,000. If you don't have or don't want to pay this cash, you could have the lender pay them in exchange for a higher interest rate, which also means a higher monthly payment.
The Downside of Mortgage Refinancing
The fees that come with refinance rates aren't the only downside. When you first started paying your home loan you may recall seeing an amortization schedule for your payments. Amortization describes the process of paying down a home loan over time.
Mortgage loans are "front-loaded" with interest. That means in the early years a larger portion of your payment goes to pay the interest instead of loan principal. Over time this gradually shifts and more and more of your payment is applied to pay down the principal balance.
The problem with refinancing is that you're resetting the clock on your home loan's amortization schedule and you'll pay down the loan balance even slower meaning you're building equity at a much slower rate.
You can offset the effects of resetting your amortization schedule by choosing a mortgage with a shorter term-length. Consider a 15 or 20-year loan instead of a 30-year mortgage. Not only can you get lower interest rates but the shorter term results in a higher payment and more cash applied to pay down loan principal.
How Do I Decide If Refinancing Is a Good Idea?
There is a gray area when it comes to weighing the cost and benefits of refinancing your home. You can calculate the amount of time it will take to recoup your closing costs by lowering your payment by using our Refinance Calculator.
You can approximate your break even point by adding up all of your closing costs and dividing by the amount your mortgage payment will go down after refinancing. This tells you (approximately) the number of months it will take to break even and start benefiting from that lower payment amount. If the amount of time is acceptable to you, then refinancing probably makes sense in your situation.
Factors That Affect Refinance Rates
Changes in interest rates are next to impossible to predict due to the number of factors that affect them. Economic conditions, government reporting, military conflicts, and even the news can all tip interest rates one way or another. Rather than trying to time the market to get lower refinance rates, your time might be more productive comparison shopping fees using lenders' Good Faith Estimates. You can compare current mortgage refinance offers using LendingTree's network of refinance lenders.
The decision to refinance your home can be an expensive proposition. If you're not sure whether taking out a new home loan would be beneficial, help is available from licensed brokers and financial advisors.