Refinancing can cost between 3 – 6% of the total value of a loan. The best time to refinance a mortgage is when the savings are more than prepayment penalties, refinancing costs, and other expenses.
1. To transfer their loan to a lender that charges a lower rate of interest
There is a traditional refinancing rule of thumb. If a new lender is offering loan at an interest that is one percent lower than your existing rate, it makes financial sense to refinance the mortgage. This rule was followed a few years back. Today’s financing gurus say that the difference in rates should be at least one to two percent to go through the hassles of refinancing.
2. To shorten their repayment period
At times when interest rates are falling, home owners see an incentive to refinance their existing mortgage into a mortgage with a shorter repayment period. A shorter repayment period will increase monthly installments. Depending on how fast rates are falling, this difference may only increase a family’s monthly installment a little. Home owners can even reduce their payment period from 30 years to 15 years if interest rates fall by more than four or five per cent. Because this huge reduction in interest rates rarely happens in the real world, home owners should expect only slightly reduced payment period.
3. To convert their existing home loan from a fixed-rate mortgage to an adjustable-rate mortgage
Fixed-rate mortgages have their advantages as well as downsides. They protect homeowners from market volatility. Homeowners know that their monthly payment does not depend on the current interest rates in capricious markets. This has an advantage for people who are looking for stability in a market where interest rates are rising. It makes sense in this scenario to change an adjustable-rate mortgage to a fixed rate mortgage.
Home owners change their loan from a fixed-rate mortgage to an adjustable-rate mortgage when interest rates are falling. As adjustable-rate mortgages depend on markets, homeowners pay less during the time of falling interest rates. A downside of adjustable-rate mortgages is that they depend on market trends. Therefore people may have to pay more during times of rising interest rates.
4. To increase their liquidity
Sometimes home owners may want to cap into their home equity to fund their child’s education, a foreign vacation, a home renovation project, or some other expensive purchase. While this may make homeowners feel rich in short term and allow them to fund some fancy purchase, they often end up prolonging their repayment period by a few years – thus paying much more.
Conclusion
Of the four most common reasons described above, the fourth makes least financial sense to refinance a mortgage. Even in case of the first three, it does not make financial sense for homeowners to lap at every opportunity to refinance to secure a lower rate of interest or a shorter repayment period.
Home Loan Advisor can analyze your property, current market conditions, local market comps, and other variables in our proprietary algorithm as well as match you with potential lenders! To assist you in the refinancing process, you can get a free home value report from Neighborhood IQ and find out what your home is really worth.
