Is Now the Time to Refinance Your Mortgage?

One of the positive consequences of the pandemic is that mortgage rates have been reduced to historically low levels. While it may seem like a no-brainer to capture a lower mortgage rate, there are several factors to consider that could have lasting consequences on your long-term finances.

Next to buying your first home, refinancing a mortgage may be the most significant financial event in your life. If done right, for the right purposes, and at the right time, a refinance can significantly improve your financial position. However, there are many moving parts to a refinance that could actually increase your costs over the long term if they aren’t entirely in sync. Understanding the process and working with a seasoned mortgage specialist is crucial to ensure your refinancing strategy accomplishes your objectives.

Why Should You Consider Refinancing?

The most important factor when considering a refinance is the reason behind it. The primary reason for refinancing a mortgage should be to improve your long-term financial picture. There are three ways a refinance can positively impact your financial situation, but each should be considered in terms of its long-term impact on your finances:

Reduce monthly payment: Many people are drawn to mortgage refinancing for the opportunity to lower their monthly payments and improve their current cash flow. While some people may need to refinance out of necessity due to changes in their cash flow situation, many see it as a way to free up cash flow to be used for other purposes. However, it’s essential to weigh the current cash flow savings against the additional interest costs over the life of your new mortgage.

Reduce the loan term: When mortgage rates decline, some borrowers may have an opportunity to shorten their loan term, thereby reducing their overall homeownership costs. In the current environment, the rates on a 15-year fixed-rate mortgage are typically about a three-quarters point lower than those on a 30-year mortgage. But because the amortization period is shorter, the monthly payment is generally higher because the principal is being paid down faster.

Cash-out equity: For some people, the equity in their homes represents a source of capital that can be used for other purposes, such as debt consolidation, home improvements, or starting a business. With cash-out refinancing, the loan amount on your new mortgage will increase by the amount of cash you want to take from your equity. For example, if you owe $150,000 on your current mortgage and your house is valued at $250,000, you could refinance the mortgage for a higher loan amount and then pocket the difference.

When Should You Refinance?

While declining interest rates are usually enough to spur mortgage refinancing activity, they are but one factor in the total cost to the homeowner considering a refinance. It is essential to consider, for instance, that refinancing a mortgage resets the amortization period of the loan, and, in the early years of the mortgage, most of your mortgage payment is consumed by interest expense. So, refinancing can have the effect of decelerating the pay down of your principal and increasing your long-term interest costs.

The optimal timing of your refinance should center on some key factors that will ensure optimal results:

• You currently have an adjustable-rate mortgage that is scheduled to reset at a higher interest rate
• You can lower your fixed-rate mortgage by a point or more (closing costs should be factored into your reduced rate)
• Your equity position will be at least 10 percent following the refinance
• Your credit standing has substantially improved, enabling you to obtain better loan terms

Refinancing a mortgage is a significant financial event with long-lasting consequences and should only be considered in light of all factors that can impact your long-term finances.