Refinancing your mortgage could help you lock in a lower interest rate, reduce your monthly payments, pay off your loan early or access equity to make home repairs or pay other bills. Despite all these potential benefits, refinancing isn’t the right choice for everyone.
Would You Get Approved for a New Loan?
If you submit a mortgage refinance application, the lender will consider your credit. If your credit scores are low, you might not qualify for a competitive interest rate. You would be better off focusing on paying bills on time and lowering your credit card balances to boost your scores before trying to refinance your mortgage. Even bumping your credit scores up by a handful of points might put you in a tier that would make you eligible for a lower interest rate.
A lender will also consider the amount of equity you have in your home. You might have trouble qualifying for a conventional refinance if you have less than 20 percent equity, although you could be eligible to refinance through a government program. Tapping into your home equity could be risky. If you couldn’t afford the loan payments, you might lose your house.
Would You Save Money?
If you can’t afford to pay for closing costs, refinancing might not be a smart move. Even if you could roll them into the loan balance, that would reduce your equity and increase your monthly payments.
Think about how long you plan to stay in your home. Refinancing might give you lower monthly payments, but it could take several years to break even. You can find the break-even point by dividing the closing costs by the amount you would save each month. That will tell you the number of months you would have to stay in the house after refinancing to recoup the closing costs. If you expect to move before then, refinancing wouldn’t benefit you financially.
Sometimes a refinance lowers monthly payments by extending the term of the loan. In the early years of a mortgage, most of the payments go toward interest. If you refinanced and extended your loan term, the monthly payments for your new loan would also go primarily toward interest at the beginning. That means you could pay interest twice on the bulk of your principal.
Some mortgages have a prepayment penalty or a charge that applies if the borrower pays off the loan early or refinances. Rules enacted in 2014 limited the circumstances in which lenders could charge prepayment penalties, but they don’t apply to mortgages that were issued before then. If your loan has a prepayment penalty, figure out how much you would owe and whether refinancing would be worthwhile.
Consider All the Financial Ramifications
Refinancing can be a way to save a significant amount of money on a home loan, but it doesn’t work out that way for everyone, since many individual factors come into play. Talk to a mortgage professional to decide what’s right for you.
