Refinancing a mortgage- whether its real estate or your own home- can be a life saver! It can dramatically cut your monthly bill, giving you the funds you need for a car payment, student loans, enjoying life or whatever you want.
Here are a few refinancing guidelines to keep in mind before you move forward. These will help you determine the best time to refinance and whether or not this is a good option for you.
Rule #1- Cut Your Rate by 2% or More
The first thing to consider is what kind of interest rate you can get by refinancing. The general rule is that if you can lower your rate by at least 2%, it’s probably a good move.
Why 2%? Because it’s a large enough cut that you could see a big drop in your monthly payments.
Here’s a good example with numbers- let’s pretend that you purchased a home for $300,000. You get a 30 year loan with no down payment.
- With a 4% interest rate, your monthly payment is $1,745 and you’ll pay $201,358 in interest over those 30 years.
- With just 2% interest, your monthly payment is $1,421 and you’ll pay $87,814 in interest over those 30 years.
So that 2% interest rate cuts your monthly payment down by over $300 and you’ll pay over $120K less in interest!
If you can’t cut your interest rate by this much, it may still be a good move but keep in mind that the payoff will take longer.
Rule #2: Get Rid of Your Private Mortgage Insurance (PMI)
When you have to borrow more than 80% of a home’s value for the mortgage, you’ll have to pay PMI each month. Even though this isn’t a big sum, it does add up over the years.
Refinancing has the benefit of removing PMI if you don’t borrow 80% of the home’s value again. So if you’ve been in the home for a few years and built up some equity, refinancing to remove PMI is a good option.
Just keep in mind that the monthly savings won’t be huge, so it will likely take a few years to make up for the money and time spent in the refinancing paperwork.
Rule #3: Help Pay for Large Expenses
Another one of the refinancing guidelines is to consider what you’re trying to do. If your home has increased in value, refinancing could be a way to leverage that extra value. You can use it for almost anything, from buying a car or remodeling the house to paying for your child’s college or wedding ceremony.
The dangerous thing about this is that we recommend using it for something you really need now or turn into potential for more money later. For example, investing the extra cash in rental property will probably be better long-term than just renovating your kitchen (unless it’s in horrible shape).
Rule #4: Plan on Staying a While
Refinancing is a perfect option for people who plan on staying in their current home for a long, long time.
But today’s housing market doesn’t see that very often. Most people move every 3-5 years. The American culture loves change and growth, but that tends to make refinancing a bad investment.
While doing the math to decide if this makes sense, you’ll find that it will take at least a few months, if not years to break even on a refinance. Every month after that is extra money in your pocket, but it still may not make sense if you’ll only be there a few more months before moving.
What Kind of Refinancing is Available?
Something else to keep in mind while you’re looking at refinancing is all of the options available to you. There are lots of different programs on the market from now, including:
- FHA Streamline Refinancing
- Home Affordable Refinance Program (HARP)
- VA Streamline Refinance
- Fixed Rate
- Variable Rate
- And more
We can’t tell you which one is right for you, as you are likely eligible for some and not others. The most important thing is to do your homework, follow these refinance guidelines and crunch the numbers to see if it makes sense.
That said, we do know that rates are going up, up, up right now. If you’re considering a refinance, look into it now before it’s too late and the rates get much higher!