If you’ve wondered about refinancing your mortgage but have dragged your feet since interest rates have hovered at historic lows for several years, you’re not alone. But you might be wondering if you missed your best chance to refinance, since interest rates inched upward slightly in December 2015, when the Federal Reserve opted to raise rates 0.25%. Experts suggest incremental increases are expected to continue throughout 2016, so if you’ve been on the fence, it may be time to take action.
But what should you consider before deciding to refinance? Even with current interest rates, which are still low, refinancing isn’t right for everyone. Here’s how to decide if you should refinance your mortgage, whether you’re considering real estate in San Antonio, TX, or San Francisco, CA.
A refinancing calculator can help you make a decision
Much of the decision to refinance revolves around the numbers: Will you really save money? Tools like Trulia’s refinancing calculator allow you to compare your current loan with the terms of the loan you would take on through a refinance. Before you use the calculator, you’ll have to organize the following information:
- Current loan information: your current loan balance, your annual interest rate, and how many months remain on your loan.
- Proposed loan information: This might seem a bit more foreign, but you can find it by researching the interest rate being offered and looking at the length of the new loan. You’ll also need to consider the fees associated with the new loan.
- Loan origination fee: This fee is a percentage of the loan amount (usually 1%).
- All other fees: In addition to the loan origination fee, you’ll need to add up the rest of the fees associated with this new loan, everything from application fees to preparation fees.
Using this information, you can calculate your break-even point (when your savings will meet your costs), as well as get a sense of how much you’ll save (or spend!) over the life of your loan.
What factors you should consider before a refinance
After crunching the numbers on the mortgage calculator, you’ll want to look at the cost of refinancing, the appraisal amount (which can determine whether you’ll actually be able to close on a better loan), and whether you’ll save enough money to make it worth the effort.
Refinancing your mortgage means obtaining a new loan, and that comes at a cost often comparable to the original loan. The origination fee typically rings in at 1% of the new loan amount, plus additional application fees ($250 to $500), document preparation fees ($200 to $400), and appraisal fees ($300 to $700). You might also be on the hook for a prepayment penalty if you pay off your original mortgage early, a title examination fee if you are going with a new lender, and various other fees depending on your lender. The general rule of thumb is, if the amount you will spend by refinancing exceeds the monthly amount you will save on the house multiplied by the number of months you plan to stay there, you might want to skip refinancing altogether.
Sometimes the decision to refinance isn’t made by the homeowner; it’s determined by what happens with the appraisal. If, for instance, the home appraises for less than what is owed, refinancing is no longer an option. Or, if you’ve built up less than 20% of the home’s appraised value in equity, you’ll likely be required to pay for private mortgage insurance and could also land less than ideal loan terms.
However, sometimes an appraisal will reveal that a home is worth more than what the lender estimates, which can open up better loan products to a homeowner based on the home’s value versus what they owe. An appraisal isn’t always a requirement (as is the case with some VA and FHA loans), but it’s important to understand how an appraisal could affect your chances to refinance and land the best loan terms available.
Being able to lower your mortgage and create a little breathing room in your monthly budget is certainly appealing, but just because current interest rates are lower than the one you locked in doesn’t necessarily mean a refinance will save you money in the long term. While some suggest looking for at least a 1% to 2% rate difference before refinancing, it’s just as important to look at the size of the loan itself. After all, a 1% drop on a $150,000 mortgage is not nearly as significant as a 1% drop on a $1,500,000 mortgage. In addition, it’s a good idea to consider the length of your mortgage. Landing a lower rate plus lowering the mortgage term from 20 years to 15 years could lead to a substantial savings over the life of the loan.
Bottom line? Make sure to crunch the numbers
Now is the time to decide once and for all whether refinancing is the best option for you. If the numbers suggest it’s in your best interest to lock in a lower rate, act now before rates rise further.