Many people wonder about the right time to refinance a mortgage. Refinancing involves additional expenses, and it's important to consider factors such as closing costs, new loan terms, and monthly payments.
There are also specific refinance rules that you should follow. If you're having a difficult time paying your mortgage, refinancing may help by lowering your monthly payment. A refinance could save you money, lower your monthly payments, and free up room in your budget—if you follow the rules.
Watch Your Rate and Your Terms
You can pre-qualify for a refinance, so only consider refinancing your mortgage if you qualify for a lower interest rate. Consider looking at different banks to see which one offers the best mortgage terms.
As with any mortgage, before you sign the papers, you should be sure that the interest rate and terms of the loan are the same as what you were originally quoted. If the rates change, be sure that you are still getting a good deal on the mortgage.
Automatic payments may qualify you for a lower rate.
Consider the Loan Length
If possible, refinance your mortgage while avoiding adding more time to your loan. The longer the term of the loan, the more you will pay in interest on the loan. If you refinance to a 30-year loan, you will lower your monthly payment, but greatly increase the length of your loan, and pay more interest in the long run.
If possible, refinance to a 10- or 15-year mortgage. However, a shorter loan length will increase the amount that you would pay per month, compared to a 30-year loan.
Don't Draw Equity Out of Your Home
Often when people refinance, they withdraw their home's equity, which might be used to start home improvements, pay off debt, finance a wedding, or fund college education. But when you withdraw equity, you are extending the life of the loan and increasing the amount of interest you will pay. You're cashing out on your investment.
If you use the money to pay off unsecured credit cards, you'll put your home at risk if you're no longer able to make mortgage payments. You may also end up underwater on your mortgage, because of the changing value in home prices. If you withdraw the equity and own less than 20% of your home, you may pay private mortgage insurance (PMI) again. Leaving equity in your home protects your abode and your financial future.
Don't Refinance to an ARM
If you're refinancing to save money on your mortgage payments, look for a low, locked-in rate instead of an adjustable-rate mortgage (ARM). An adjustable-rate mortgage could move to a higher interest rate in a few years, which will raise your payment amount.
Locking in a lower rate will save you more money in the long run.
Find Favorable Terms With Your New Loan
In addition to looking at the interest rate and length of the loan, read the fine print carefully, and make sure that terms are acceptable and favorable. Find out what happens if you are late for a payment. Different companies may enact different penalties, including late fees or an increase in your interest rate.
Find out how long you have before your home goes into foreclosure. Also, find out if there are prepayment penalties. Some lenders will not allow you to pay off the loan early for a set number of years, or they may not credit extra payments to the principal amount of the loan.
Be sure PMI isn't added on if you don't owe more than 80% of your home's value. Some mortgage companies will require or add in insurance, and drive up your mortgage payment with the cost of these unnecessary services.
Consider these details before you refinance, preferably with more than one offer in hand, and ensure the terms are favorable to you.