In an uncertain market and economic environment, it pays to take advantage of all the sure things you can get. A prime example is paying down any debt you have, even mortgages and other loans that some might classify as “good debt” because they carry relatively low interest rates and may offer tax deductions. By chipping away at your borrowing costs, you’ll reduce the interest you owe over the life of your loan. With that being said, it’s a good time to investigate whether it benefits you to refinance your mortgage. In an effort to jump-start the moribund economy and jumbo loans threshold housing markets, the Federal Reserve has aggressively cut interest rates, which has brought both 15- and 30-year mortgage loans down to historically low levels. Rates have continued to fall in 2012, with the most recent July 30-year mortgage loan at 3.55%
You should consider refinancing if one or more of the following applies to you:
• Your current interest rate is appreciably higher than prevailing rates. There are a number of nifty calculators on various websites to help you determine this (www.bankrate.com is a good one).
• You plan to stay in your home for several or many more years, thereby increasing the likelihood that you’ll recoup your closing costs over the life of the loan.
• You have an adjustable-rate mortgage with a currently low interest rate but plan to stay in your home for several more years and would like to lock in a relatively low fixed rate.
• You would like to switch to a shorter-term mortgage with a lower interest rate—say, you have a 30-year loan and would like to swap into a 20-year loan. Just be sure your job is rock-solid before increasing your monthly debt. If you’re concerned about job security, you can still refinance but instead stick with the same term and make additional payments on principal.
• You have a jumbo, or “nonconforming,” loan that may no longer be considered jumbo. The threshold for jumbo loans is $417,000, but in certain high-cost parts of the country the thresholds are now higher. Jumbo loans usually carry higher rates than do non-jumbo loans, so if you can do away with that categorization, you’ll be in a better position. Even if your loan still lands in jumbo territory, you may be able to secure a lower rate.
• You have great credit—650 or ideally even higher—and you haven’t lost your job or missed a mortgage payment since you secured the loan.
• You have a decent amount of equity in your home—ideally 20% or more. However, you may still be able to refinance if your home is now worth about the same as your loan value or even a little bit less; check out http://makinghomeaffordable.gov for details about refinancing for those whose loans are now 105% or less of their property values.
• You have the cash on hand to cover the closing costs up front. The 2009 Closing Costs survey conducted by bankrate.com put the average home loan’s closing costs at $2,732. By fronting the closing costs, you’re likely to be able to obtain a more favorable loan rate.
After reading the above characteristics, you can determine when refinancing might not make sense (if you already have a low rate, won’t be able to recoup your closing costs, etc.). In addition to those that are fairly clear-cut, you should also keep in mind that your property will need to be reassessed as part of the refinancing process. This might force you to have to pay private mortgage insurance. Lenders assess PMI when a loan is more than 80% of the current value of the home. Finally, you might have had a mortgage for many years and are seriously chipping away at the principal. If that’s the case, refinancing, and thereby extending the term of the loan, could increase the total interest you’ll pay, even if you’re able to reduce your monthly payment.
©2013 Morningstar, Inc.