When to refinance a home

refinance a home

Did you know that according to a recent study published in the Journal of Financial Economics, American homeowners have lost $5.4 billion because they’ve failed to refinance their mortgages when they should have?

Mortgages are simply loans secured by private property, with an annual interest rate and monthly payments. Normally, Americans tend to opt for 30 year fixed mortgage rates, which of course have their pros (i.e. lower monthly payments to save more money) and cons (i.e. riskier for institutions).

However, because unlike the first time you took out a mortgage you own property now, refinancing becomes much easier. So if you’re interested in saving money by refinancing your mortgage, find out when it’s the best time to do so next.

#1 If you plan to stay at your house for several years

When refinancing, it’s important to consider whether you plan to stay in your house for several more years, or if you plan to move in some time. Mortgage experts estimate that the average time homeowners stay in their house is 7 years. If you plan to stay at your home for that long, then you can get a better interest rate.

However, if you’re planning to move soon, you shouldn’t refinance your debt. Closing costs will outrun all savings possibility of refinancing.

#2 If you have money problems

If you lose your job, your salary gets cut back, if your kids are starting school or by some reason you aren’t able to afford your payments, then refinancing is a good way to save some money.

If you have some extra cash to take care of the closing costs, then it might be a sensible option refinancing your mortgage from a 30 year-loan to a 15-year one. This way, you can adjust your mortgage to your new situation. And if the situation improves, then you can increase your mortgage payments to pay back the money faster.

#3 If your credit score has improved

If you have improved your credit score since getting the original mortgage, now you might be able to qualify for a lower mortgage interest rate. To make sure this is your case, simply check your credit report. If in the last few years you’ve met your mortgage payments a timely manner, then you’ll probably have improved your credit score.

Also, remember to compare your debt with your income to those you had when taking the first mortgage, since banks ask their clients to have a debt to income ratio below 36%.

#4 When you have less than 20% of equity

Before discussing this point, let’s consider the concept of equity: basically equity means the sum of your assets, in this case the value of your house. Normally home value increases over time, which generally leads to an increase in equity.

This means that if you have a good amount of equity you can easily qualify for a loan and refinance your house. The ideal percentage is 20%, however in some cases 10% can be enough to be able to refinance your loan.

#5 When you have a second mortgage or a home equity loan

Refinancing your loan can help you save money when you have a second mortgage, a home equity loan or a home equity line of credit. To see if refinancing is possible, simply add up all your home loans: if this sum is lower than the value of your home, then you might be able to refinance all your loans into only one loan and pay one low rate amount.

#6 When the break-even point makes sense

Mortgage closing costs can be very expensive, so in order to figure out if refinancing your loan makes sense, you can calculate your break-even point, which is basically the time it takes for the mortgage refinance to pay for itself. The formula is as follows:

Break-even point = Total closing costs ÷ monthly savings

For example: $3,000 in closing costs ÷ $100 a month in savings = 30 months to break even.

If you plan to stay at your house for less time that the one needed to break even, then refinance doesn’t really make sense, simply stay in your mortgage.

Useful tips:

  • Mortgage interest rates vary notably, so in order to find the best mortgage rates, make sure to use available tools online to find the cheapest ones, such as CFPB.
  • Although many banks advertise “no-cost” mortgages, these kind of loans do not exist. However, you can get no out-of-pocket cost mortgage, where closing costs are added to the loan balance, o pay a higher rate to cover them.
  • Closing costs vary according to your mortgage interest rate, so for the lowest available rate you’ll pay relatively high closing costs. If you have a slightly higher rate, you’ll pay less costs.
  • Careful! Some banks have loans with a mortgage prepayment penalty, which means lower fees or a better rate, but if you pay the loan off early you’ll have to pay an expensive fee. Also, if you refinance your mortgage before the penalty expires, you’ll also have to pay the penalty, which might make refinancing more expensive.