When my husband Rob was assigned to the Pentagon, we purchased a wonderful home in Fredericksburg, Virginia. We were only thinking of being close to his mother, but as the DC area expanded, Fredericksburg became the new bedroom community for commuters. Home prices soared, just as interest rates were going down. We decided to refinance. We not only got a lower interest rate but used the increased value of the house to pay off our other loans and even purchase a home for a family in Haiti through Food for the Poor.
We had lucked into the perfect situation for refinancing our mortgage, but there are plenty of times when you should refinance. Read on for more about getting the most from refinancing, and if you're interested, check out our reviews on mortgage and refinancing companies.
What Refinancing Is and What It's Not
When you refinance your mortgage, you are securing a new loan on your house with which you pay off your existing mortgage. You then only make house payments to the one lender. This differs from a home equity loan, in which you are securing a second loan based on the equity you already have in your house to get money for other expenses.
In some cases, it's possible to refinance for more money than you owe on your home. You can use that money for other things, such as home improvements, education or to pay off high-interest debts. However, keep in mind that whatever extra money you take out, you'll spend 15 to 30 years paying back, and if you cannot make the payments, you could lose your home.
The advantage of refinancing lies in lower interest rates and better terms, but you have to offset those against the cost to refinance, such as closing fees and appraisal fees. In many ways, the process is similar to getting a new mortgage. You can read this article for details on the refinance process.
When Should You Refinance?
The biggest benefit for refinancing is to save money by getting a loan at a lower interest rate. Therefore, it makes the most sense when you can get a far lower interest rate than you currently have. However, there are other fees involved, including closing costs that can run thousands of dollars, and you may end up adding years to your mortgage. Those factors should be balanced against your decision.
If you can pay off your current mortgage in the next couple of years and are keeping the house, it does not make sense to refinance and stretch your payments out over 10 to 30 years. You may even end up paying more in the long run because of all the accumulated interest.
On the flip side, if you are planning on selling your home and are confident you will get enough to pay off the loan plus the fees, you might benefit from the smaller monthly payments. In this case, you may even negotiate to have the fees folded into the loan. However, you again need to do some math, because it's possible you might be paying off a bigger loan amount than if you'd simply kept the higher payments for a year or two. In other words, you pay a little less each month but end up losing any profits from your sale later.
Lower payments are another advantage for refinancing. This frees up some of your income for other things, whether paying down other bills quickly or investing that money for your retirement or your children's education. In fact, if invested wisely, your money could earn you enough to make additional payments worth the longer terms.
A refinanced loan is also worth it if it lets you pay off your home sooner. Say, for example, you've been paying $890/month on your mortgage and now owe $100,000. If you refinance to $580/month but continue to pay the $890, you're putting an extra $310/month into the principal. You would pay off your home over eight and a half years early, saving you $17,800 in interest.
In the course of our time in the military, my husband and I had many opportunities to refinance our homes. However, we didn't often do it. While the lower rates can be tempting, they sometimes weren't enough to offset the fees. Other times, the prices of homes were falling, making refinancing problematic. Still other times, it simply wasn't worth the effort because we were moving soon.
You may not have as many factors as we did, but when considering refinancing, be sure to look at the whole picture, especially what it costs to refinance, in order to make the decision that makes the most financial sense in the long run.