How committed are you to the house?
It is commonly understood that refinancing is only profitable if you plan to stay in the house at least three years. Unless you can snag a lender who will forego refinancing costs, you have to be able to save $100 or more per month in interest to make refinancing profitable. Fees and prepaid interest can eat up any savings before you make the first payment on the new note. If you plan to sell the house within a couple of years, it may be cheaper to leave the loan as it is.
What is your reason for refinancing?
The best reason for refinancing is to reduce your interest rate and save money. Unfortunately, many mortgages are refinanced because the home owner needs access to some of the homes equity. This might be for repairs, debt consolidation, or to make some type of large purchase.
While any of these may be excellent reasons to pull cash out of your home, getting cash from your house can cost you money. Your lender may insist on higher interest or more cash at closing because you are increasing the size of your loan. The same is true if your intent is to extend the length of the loan to get a lower monthly payment.
Determine the interest savings per month and over the life of the loan.
This may sound like different versions of the same thing. If you are extending your loan, you may pay less per month for interest, but pay more over the life of the loan. You need to be cautious about loan extensions. If you add 10 years to a 10 year note, a $100 per month interest savings will amount to $24,000 in 20 years. However, if you have a $500 per month payment, you have just turned $60,000 in payments into $120,000 in payments. Instead of saving $24,000, you will spend an extra $36,000.
Get all of the refinancing costs in writing from your bank.
Because you do not want to create more problems than you solve, make sure that you have all of the refinancing costs clearly presented. Refinancing costs can vary hundreds and sometimes thousands of dollars from one lender to another. An attractive interest rate can be a bait and switch opportunity if the refinancing is loaded with high up front fees and prepaid interest points.
Banks may require you to have extra equity in the house.
Loans involve risk for the lender. Your refinancing institution may have minimum equity qualifications to get low rates or even to offer you refinancing. If you moved into your home with less than 20% down a year or two ago, the few hundred dollars that you have retired from your original principal amount will not be enough to be interesting to bank loan officers. Refinancing to a low rate may require that you add some cash to your stake in the house to get the equity up to 20%. In an expanding housing market, two or three years may be enough for inflation to add back enough equity to offset a low original down payment. In a flat or shrinking market, this is unlikely to be the case.
Can you get other more favorable terms besides interest savings?
Interest rates are not everything in mortgage lending. You might want to find a lender with better grace period options if you cash flow can vary from month to month. Try to find a bank that offers refinancing with the lowest up front fees. Watch for punitive late fees. Make sure that there are not severe penalties if you get to pay off your mortgage early. Having options to make your payments online or through automatic deductions may be preferable options for some people.
In short, you should do the math before you agree to refinance your mortgage.
Make sure that what looks favorable for you actually is. If you have problems reading the fine print or understanding the arithmetic, get some trusted help to guide you through the process. Refinancing is a one-way trip. You cannot say “oops” and undo it.
