Important Factors to Consider Before Refinancing

With mortgage rates still hovering around historic lows, many homeowners are wondering if they should refinance. When considering refinancing, you should look at these four key factors:

Your current interest rate. Typically, if you are able to lower both your mortgage rate and your payment, it could be worth refinancing. While conventional wisdom is that a 1% rate drop justifies a refinance, you could benefit from even a .25% rate drop if you have a large balance on your loan. If you have a small balance, it may not make finance sense to refinance unless you can get a rate drop of 2-3%.

Cost of refinancing. When you refinance, you will likely have to pay closing costs, just as you did when you first purchased your home. To determine if it’s worth it, take the cost of your refinance and divide it by how much you are saving per month to figure how long it would take you to recoup those costs. For example, if you save $100 per month and your closing costs are $5,000, it would take you 50 months to “break even.” If you will be moving before then, it’s not worth it. There are also some lenders that offer no-cost refinancing in exchange for a higher interest rate, thereby eliminating the closing costs.

Effects of extending the loan term. When you refinance your loan, you “re-set” the pay-off date and need to examine the effects of paying your loan over a longer period of time. However, many people sell their home before they pay off their mortgage, so this would probably not be a consideration if you plan to sell before the loan retirement date.

Your home equity. In order to qualify for refinancing, your lender will require that you have some equity in your home. Generally, the more equity you have, the easier it is to refinance.