Almost every homeowner has gotten the call at least once: an eager telemarketer, trying to convince you it’s the best possible time to refinance your home. Is it a scam, or is it really the ideal moment?
A telemarketer can’t tell you the answer to this, because much more goes into the decision to refinance than interest rates. How long have you owned your home? What are your goals for your equity? Can you afford your mortgage payment?
What Is Refinancing?
Refinancing your home means replacing your current home mortgage with a new mortgage at different—hopefully better—rates. Like a new home mortgage, your new mortgage will involve loan origination fees, credit checks, and an appraisal. But it’s done while paying off your current mortgage, so instead of having to come up with a down payment, you will sometimes get cash out of a refinance.
Expect a home refinance to take several months. You can’t know for sure what kind of terms you will get until your home has been appraised. If it’s increased in value since you bought it, you may find the terms are much better than your original mortgage. But an online calculator can’t accurately tell you your home’s value. The appraiser, hired by the mortgage company, will come up with their own number.
You’ll have a number of options in your home refinance, which you should discuss with your loan officer. For instance, you can replace an adjustable-rate mortgage (ARM) with a fixed-rate mortgage. You could get a mortgage with a shorter or longer term than the original one. You could take cash out of the refinance, or keep all your equity in your home and instead try for a smaller payment.
Why Might You Refinance Your Home?
There are endless reasons why a person might choose to refinance their home. Any time the initial terms of your mortgage weren’t the best, a refinance is something you’ll consider for the future. If you had to buy at high interest rates, if your credit wasn’t good at the time, or if you had to get an adjustable-rate mortgage, a refinance will seem particularly attractive.
A cash-out refinance is a common strategy when you need money to renovate your home, or for some other one-time expense. You might want a longer-term mortgage if your budget needs a lower payment. Or, if you can easily handle a larger payment, you could switch to a shorter-term mortgage to get equity in your home faster.
Refinancing is also common during divorces, in order to divide the equity between the spouses without losing the home itself. It also replaces the joint mortgage with a mortgage in one spouse’s name.
Some people refinance to consolidate debt, taking cash out to pay off high-interest debts like credit cards. While this does reduce the amount of interest you’ll pay, it doesn’t actually decrease your total debt. It’s vital to pair this strategy with long-term habits that reduce your debt.
Why Shouldn’t You Refinance Now?
With all these reasons to refinance, why wouldn’t you jump on the opportunity? The biggest reason is the loan origination costs. A new loan will cost 3-6% of the loan amount, plus any number of fees. That’s why those telemarketers are so eager to talk you into it. It will take several years of reduced payments or interest before the new mortgage pays for itself.
Experts recommend not refinancing if you’ll only live in the house a few more years. If you’re doing it for a lower interest rate, only sign a loan that charges at least 1-2% less in interest than your old mortgage. Currently, mortgage rates are starting to rise, so it may not be the best time.
If you’re hoping to get cash out, consider your plans for your equity. Most people use their equity for their next down payment when they move. Are you planning to stay put for a while? Will the cash you take out increase the value of your home in renovations and replenish your equity? Or do you have another smart investment to make with it, such as paying off high-interest debt? If not, say no to that tempting offer of cash. It’s not money for nothing—it’s borrowing from your own future.
Stick to a Comprehensive Financial Plan
Whatever you do, it should be part of your long-term financial strategy. Do you have a comprehensive financial plan, spelling out your goals, strategies, and priorities? If not, you should speak to a financial advisor about creating one. We can match you with the right person with a quick phone call.