Should I refinance my mortgage? Below you can find everything you need to know.
In this article
I recently went through a mortgage refinance myself – it was seamless and very smooth.
But that’s also because I knew exactly what I wanted in a refinance, which questions to ask, and who to contact.
One reason why my refinance has gone so smoothly is likely because I have experience in the finance world and have helped several individuals through a refinance before I applied for a refinance on my own.
For those of you who have not worked in the finance world or who have not helped walk someone through a refinance – it can be a challenge.
Specifically, it can be difficult to know whether a refinance is the right thing for you.
And that’s why I wanted to write this blog today – to help walk you through the thought process of whether a refinance is good or bad for you.
I’m sure many of you have recently heard the term “refinance” being thrown around in the news or just simply in conversation with possibly colleagues, friends, or family.
Due to recent market and economic volatility, interest rates have plummeted to new all-time historical lows. What does this mean for you?
It’s time to take advantage of these low rates — assuming several factors line up for you, which I have described below.
What is a refinance?
First and foremost, let’s begin by discussing the significance of a refinance.
Essentially, refinancing your mortgage just means taking your current debt (your home mortgage) from the hands of your current lender (the person who is taking your making monthly payments) and dumping that debt into the hands of another lender (so you’ll start writing monthly checks to someone else).
Why would you leave the status quo to refinance?
Simply put – one of the top reasons why people decide to refinance is because there’s something in it for them.
For example, 2 common reasons why people decide to refinance include:
Lower Interest: Your new lender offers a lower interest rate on the amount of money you owe
Lower Payments: The monthly checks you write to your new lender are not as high as with your old lender
Refinance mortgage pros
Of course, there are several reasons why it’s beneficial to refinance – or else so many people wouldn’t go ahead and start the process.
Below are 3 positive aspects of refinancing:
Lower interest rate
As mentioned earlier, with a refinance, you can lower your current interest rate on the amount of money you owe.
This in turn means you are paying the bank less (because you have a lower interest payment) and more of your money is going to paying off your home.
For the Nerds: Let’s say you have a $100,000, 30-year fixed term mortgage with a 4.5% interest rate.
How much will you pay on a monthly basis: $506.69.
That means every month you pay $506.69 to your lender.
The question now is how much of this $506.69 is actually going toward paying off your home – because there is that 4.5% interest rate which the bank is charging YOU because they are loaning you money.
Well, there’s a thing called an amortization schedule.
In basic terms, an amortization schedule breaks down your monthly payments over the duration of your loan (so over 30 years, or 360 months).
The amortization schedule literally shows you from Month 1 to Month 360 how your payments are divided up – how much from each of the $506.69 monthly payments is actually going toward the bank and how much of that $506.69 is going toward paying off your house.
In this case, in Month 1 with a 4.5% interest rate, of the $506.69, you’ll be paying $375 toward the bank and only $131.69 of your payment is going toward paying off your home!!
What if you lower your interest rate from 4.5% to 3.5%?
How would your Month 1 payments change?
First, they would decrease from $506.69 to $449.04 – and second, your Month 1 payment would be divided up as follows: $291.67 to the bank and $157.38 going toward your home.
By lowering the interest rate, notice the following:
Your overall monthly payment decreased by $57.65/month – that means almost $700/year of savings or extra cash in YOUR pocket, just by refinancing
The amount of money you pay to the bank decreased (that’s a win)
The amount of money you pay toward your home increase (also a win)
Spoiler Alert: When you take out a mortgage, typically you’ll be paying the bank back a majority of the interest before you really start chipping away at paying off the principal of your house (what you actually bought your home for).
This is what an amortization schedule is able to illustrate.
One such amortization schedule can be found here.
More money in your pocket due to increased cash flow
As we saw in the above example, if you lower your interest rate, typically you will find that on a monthly basis you will pay LESS per month.
This means more money in your pocket – which I hope you’ll be able to put toward either an emergency savings fund, pay off bad debt (such as credit card debt), or even better use to invest for the long term.
Possibly pay off your debt faster
How can pay off your debt faster?
By refinancing to a shorter-term loan!
In other words, instead of paying your mortgage for 30 years (which is a common term), through a refinance, you could elect to pay off your mortgage in 15 or 20 years for example.
What does this mean? You’ll own your home in a shorter period of time.
But be careful – there is no such thing as a free lunch. If you decide to refinance your loan to a shorter-term, then that means your monthly payments will very likely increase to make up for the shorter period you’ll be paying.
Let’s use the same numbers we used in the previous example above: $100,000 30-year mortgage at 4.5% yielded a monthly payment of $506.69.
Now consider cutting this term in half to 15 years: $100,000 15-year mortgage at 4.5% yields a monthly payment of $764.99.
Your monthly payment just increased by $258.30 or close to $3,100 per YEAR.
If you are resolute and want to cut the amount of time you make your monthly mortgage payments, make sure that you have the cash flow (meaning income) to do so because chances are, your monthly payments will increase.
Refinance mortgage cons
You could extend the amount of time you pay your house due to increased mortgage term
What if you have a 30-year mortgage and are already 9 years into paying off your loan?
All of a sudden, you decide to refinance your existing mortgage to a 30-year loan because of a sudden drop in interest rates.
Is this the right move?
Probably not – because you have just restarted the 30-year clock, meaning you will have to start paying the bank for another 30 years.
At this point, it probably makes sense to refinance to a 20-year term or possibly even to a 15-year term (assuming you have the cash flow to pay for an increased monthly payment – as discussed in the above example).
Pro Tip: Typically, if you have paid 5 years or more into the mortgage, you’ll want to go ahead and refinance to the next lower refinance option.
In other words, if you have a 30-year term mortgage and are already in your sixth year of paying off this mortgage if you are considering refinancing it is generally suggested to consider a 20-year mortgage instead of re-refinancing to a 30-year (because you’ll be restarting that 30-year clock).
Fees & closing costs
Remember how I said there is no such thing as a free lunch?
Well, this is where your new lender will get you – IF you don’t know which questions to ask and where to look for.
So let me walk you through some things to know.
First, in exchange for lowering your monthly payment or your interest rate – or likely both – your new lender will most likely charge you what is known as a closing fee (to close on the new loan) and some other miscellaneous fees.
These closing costs and fees could add up to a few thousand dollars (this is normal).
The average closing costs on a refinance can generally range between $4,000 on the low end to somewhere around $7,000.
Anything more than $7,000 in fees, I would suggest to shop around and find another refinance quote to see if another lender can offer you a better deal.
Since most people don’t have the extra cash to pay the several thousand dollars in closing costs, typically people do what’s known as “roll” their closing costs into their existing mortgage.
This means that if you have a total of $5,000 in closing costs and an existing mortgage of $100,000, your new “refinanced mortgage” would actually be equal to $105,000.
This move could make sense if you are lowering your interest rate, for instance.
Make sure you weigh the savings aspect along with the closing costs (which are likely added to your existing mortgage, temporarily increasing the amount of debt you owe).
Pro Tip 1: Don’t settle on the first refinance offer you receive.
Even though a lower interest rate might sound appealing – don’t forget to review how much in closing costs your new lender will charge you.
If it’s too much (I’ve seen refinance quotes with over $11,000 in closing costs – which is egregious), say thank you, and look for another quote.
Pro Tip 2: AVOID points in your refinance costs.
Points is a fancy word for fees that you pay your new lender once you sign the paperwork at your refinance closing. In short: Points = money out of your pocket.
Don’t do it and make sure you request for 0 points when you look for a refinance.
Yes, your credit score could be impacted by electing to refinance your mortgage.
The main reason behind a refinance impacting your credit score is because, in order to undergo a refinance, you have to allow your new lender to pull your credit score.
And every time you have someone run your credit score, it negatively impacts your credit score.
Sometimes that impact could only be by a few points – it’s hard to say by how much your credit score could be hit.
Don’t be afraid to have your credit score run, either.
If you see a chance to lower your current interest rate through a refinance, then there is no reason why you should hesitate to have your credit score run just to avoid seeing your credit score drop.
Pro Tip: Even if you have your credit score run, it generally takes a few weeks (or even months in some cases) for the activity to register and cause an impact on your score.
When should I refinance?
There are several factors that go into this question and whether a possible refinance is the right decision for you.
#1: If you plan to stay in your current house for a long time (i.e. more than 5 years) generally, the break-even period for a refinance can be anywhere from a few months to up to 5 years.
#2: If you decide to stay put in your home for 5 or more years, you’ll generally be making a profit if you lower your interest rate and save on your monthly bills.
However, if you are considering refinancing and moving in a few years – that’s probably not the right time to refinance.
Why? Don’t forget the closing costs associated with the refinance.
At this point, it might not be worth refinancing and just wait it out.
#3: Able to obtain a new interest rate that’s about 0.75% or more indifference compared to the old rate.
Typically, if you can find an interest rate that’s 0.75% percentage points or more indifference compared to your current one, it might make sense to go through with a refinance.
For example, if your current interest rate is 4% and you are considering to refinance to a 3.1% interest rate, it could make sense to do so (assuming closing costs are reasonable).
#4: Can you qualify?
To undergo a successful refinance, you also have to consider whether you (and your home) would qualify.
In other words, you have to consider if your new lender would even consider loaning you money based on the quality and value of your home as well as your dependability to repay your future lender.
#5: How does your future lender decide whether to give you a loan?
By running your credit score (which was discussed previously), by reviewing if your home has any additional debt (such as a home equity line of credit).
Find out more about HELOCs here and whether your income even qualifies you to obtain a new mortgage.
As an example, if you just lost your job and have no income, the likelihood of you obtaining a new mortgage is fairly low because you have no income to pay for the recurring monthly bills.
You have to prove that your income is sufficient to pay off your mortgage to your lender.
My refinancing journey
Now, I recently underwent a refinance myself and I wanted to share my journey with you.
Like I mentioned at the beginning of this post, my refinance journey actually went fairly smoothly, but I also knew what to ask and I knew exactly what I wanted to do.
One of my biggest tips to everyone out there who is considering a refinance is to look for new lenders at one of the two places:
A local lender
An online lender
A local lender will likely yield better interest rates than one of your larger institutions.
For example, when I was looking to refinance my home, I compared interest rates at national and internal lending institutions and banks versus those interest rates offered by my local bank.
Come to find, my local banks offered me interest rates sometimes up to 1% better!
Moral of the story: Don’t go with your national bank. Go local and you’ll likely be rewarded with a lower interest rate.
Believe it or not, online lenders often actually yield better interest rates than your national bank OR your local lender.
Simply put, it’s because online lenders don’t need to pay for your brick and mortar stores – they don’t have to keep the lights on and pay the monthly rent.
They’re based online so they have less overhead costs, which in turn means they can afford to charge the end consumer – you – less money (in the form of a lower interest rate).
Where should I look to refinance?
There are 2 places I would recommend you to start your refinance journey:
As I discussed in the previous section, local banks generally offer better interest rates than national banks
The following website not only provides you with multiple online lender names for comparison but also gives you a detailed view of typical closing costs as well as points charged for a refinance: Zillow.
Make sure to do your research before you commit to a refinance.
Even though a lower interest rate might sound alluring – be wary of potentially high closing costs and possibly increasing your mortgage term beyond what you were hoping for.
If you are committed to refinancing your home, then some of the best lender options could be either your local banks or possibly online lenders, who could yield you with the lowest possible interest rate.
All in all – do your research before committing to anything. Good luck!
Recommended reading: How to buy your first home
Have you refinanced your house? What was the experience like?