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When Should You Refinance Your Mortgage? 

  • August 17, 2020

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Due to COVID-19, interest rates on mortgages have reached lower rates than ever; many are considering refinancing their homes to take advantage of this. There are a few reasons why a homeowner may choose to refinance their mortgage - it can reduce monthly payments, shorten a mortgage term, provide cash for a large purchase, or lower the interest rate. But is it a smart thing to do with your money? The answer depends on your specific financial situation.

Refinancing is a good idea when it allows you to reduce the interest rate on your current mortgage by at least 2%. You can also refinance to shorten the term of your mortgage, which will allow you to pay less in interest over time. While it will increase your monthly payments, you’ll save more by paying less on interest due to the shortened term - consider the interest savings on a 15-year mortgage versus a 30-year one. It can amount to tens of thousands of dollars saved! This allows you to pay off the loan more quickly. If your income is in a precarious position right now due to COVID-19, it is not advisable to refinance. This can make it difficult to make payments and could result in bankruptcy. 

Some consider refinancing to consolidate their debt. A single mortgage is easier to make payments on and has a lower interest rate than multiple personal loans or credit card debts. If you want to refinance because you are in debt, whether because of bills or car payments, you may want to take caution. This move can be risky and result in even more money owed. There are other debt relief steps you can take. You can try to negotiate directly with your creditors, or you can try traditional debt management by cutting your spending and boosting your savings. This major financial decision may be helpful, but only if you are confident that you will be able to keep up with your mortgage payments.

Refinancing your home comes with a closing fee, usually between 3-6% of the principal amount of the loan. If you’re considering this option, weigh the costs and benefits; will you be able to justify this fee, or will it outweigh any possible gain? Calculate how long you intend to remain in your home to see if the refinancing will pay for itself, or if you’re better off staying with your current mortgage. For example, if you are refinancing to get a lower interest rate, calculate how many years of payments would amount to the cost of closing a loan. Then, ask yourself if you plan to stay in the same house for that time. This will help you judge whether or not refinancing is worth it. One reason that people refinance is to make major renovations on their home, such as a roof repair or building an addition. Remodeling can add value to your property, which can justify the expense of refinancing. Again, it is worth asking yourself when you plan to sell your property; if you plan to do so within a year or two, the cost of refinancing may be greater than any potential savings. 

Are you considering refinancing your home to repay other debts? This may be advisable in circumstances where those debts have higher interest rates. You may not be able to eliminate all your debts at once, in which case, you need to find out which ones should take priority. Figure out which debts you should pay off first. The biggest determinants of that are interest fees - debts with high interest rates should be paid off first. If you owe money to a business that’s important to you, you may want to prioritize that debt to avoid damaging that relationship. If you’re going this route, it’s important to plan on paper how you will repay your debt. Otherwise, refinancing can land you in even more money trouble. 

Even when interest rates are at a historic low, it may not be the best choice to refinance your mortgage. The answer depends on a multitude of factors, like how long you intend to stay in the house. So, how do you know whether or not you should refinance your mortgage? If it will help you build equity, save money, increase the value of your home, or pay off your mortgage faster, then this decision may benefit you financially.