When is the Right Time to Refinance?

in Budgeting, First Person: Our Blog, Interest Rates, Mortgage, Personal Finance

When mortgage interest rates fall, homeowners’ thoughts often turn to refinancing. There are a number of good reasons you may consider it: reducing monthly payments or the length of your mortgage, converting an existing adjustable rate mortgage (ARM) to a fixed-rate (and in some situations, going from a fixed-rate to ARM) or using the equity in your home to pay off credit card debt, school loans or for something more fun, like a major purchase or the vacation of your dreams (more about that later).

But, as appealing as that lower interest rate may be at first glance, it’s not as cut and dried as it might seem: it’s important to take your current finances – and what you stand to gain by refinancing – into consideration before making your decision. Appraisal, title search and application fees are just part of the expense involved in the process, so affordability is always an issue. The length of time you’ve been in your home, how long you plan to remain…these, too, are critical factors to analyze before concluding that it’s time to refinance.

The reason most homeowners refinance is to lower their interest rate…and their monthly payments. Generally speaking, the time is probably right if you can reduce the rate by 2% or more. However, even a reduction of as little as 1% can be noticeable.

If the interest rate has dropped a lot, you might want to look at a shorter term loan – going from 30 years to 15, for example. In these cases, the shorter term may represent only a little bit more out of your pocket each month (our 15 vs. 30-year Fixed Mortgage Calculator can help you figure out your monthly payments and savings). If your budget can handle it, what you save with the reduced interest you pay over the life of a 15-year loan may completely outweigh the slightly larger monthly payment amount.

Some buyers purchase their homes with an adjustable rate loan, because an ARM usually offers lower initial rates. When the adjustment periods come, however, there may be a rude awakening: the new monthly payments could make it worth the time and cost to convert to a fixed-rate loan. In fact, the advantages of refinancing in a case like this are twofold: lower interest rates in the short term and cost certainty over the life of the new loan. On the other hand, if your medium-term plans involve moving (say within 5 years), it might make sense to refinance from an existing fixed-rate loan to an ARM in order to take advantage of that lower introductory rate.

So far, each of these refinance scenarios are financially sound. The next one can be, too – but you have to go into it being aware of the potential snares along the way!

When mortgage rates are lower, you might be tempted to access home equity for cash – what’s known as a cash-out refinance – to cover planned (or emergency) expenses, such as home remodeling, an unexpected major car repair or your kid’s college tuition. While none of these are necessarily bad reasons to refinance, counting on your home equity as a “bank” can have some unexpected consequences. Before you commit to a cash-out refinance, take a long look at your immediate need versus the added years of mortgage payments – and interest – you’ll incur with a new loan.

Consolidating credit card and other high-interest debt using a cash-out refinance is a practical decision – after all, trading several higher interest rates for a single lower one is sound thinking. However, for it to really be worthwhile, you’ll probably have to practice a little restraint. Just because the old obligations are retired, acquiring new debt defeats your purpose. If the goal is to eliminate long-term debt, follow through and resist the urge to plan that dream winter vacation in Hawaii simply because “there’s room on the card”.

Bottom line, when should you refinance?  It’s totally worth it when getting that lower mortgage rate is affordable for you in the short run and makes good financial sense long term. To check First Internet Bank’s current rates and see if that time is NOW, click here or call one of our experts at 866-742-5158.