Owning a home is the American Dream, and if you’re like most, your mortgage payment accounts for a significant portion of your budget. Refinancing can help lower your costs and potentially save you money, but how do you know if it’s the right move?
Whether refinancing makes sense hinges on what you stand to gain. Here are four scenarios where a mortgage refinance could pay off.
You have an adjustable rate mortgage (ARM) and rates are going up.
Your interest rate matters because the higher the rate, the more you pay for your home in the long run. Adjustable rate mortgages are tempting because you can snag a lower, introductory rate during the early years of owning a home. What you need to be mindful of is how your loan rate could change after those first few years.
If interest rates start to increase, you could be looking at a higher rate when your ARM adjusts. That could make your mortgage payments less affordable and put a strain on your budget that you don’t need. In this case, consider refinancing to a loan with a fixed-rate mortgage and sidestep that problem.
When you refinance to a fixed-rate loan, you get predictability in return. The fixed rate may be slightly higher than your initial ARM rate, but you don’t have to worry about it changing. And it’s a lot easier to account for all your expenses when your mortgage payment remains consistent from month to month.
You’re looking to reduce your monthly payment.
If you’d like to shrink your mortgage payment, you have two options. The first is to refinance at a lower rate.
For example, let’s say 10 years ago you took out a 30-year, $250,000 fixed-rate loan at 6 percent. You decide to refinance into a new 20-year mortgage with a rate of 4.625 percent. That drop could free up $187 each month. Over the life of the loan, that’s a savings of more than $78,000.
Pretty significant, huh?
You could take the money you’re not spending on your mortgage and use it to save for retirement or put it away for your kids to use for college.
The other way to lower your monthly mortgage obligation is to refinance into a longer loan term. Using the previous example, if you refinance into a new 30-year loan, your monthly payments could decrease $470.
Of course, there’s a trade-off with refinancing to a longer loan term. Even if you lock in a great rate, you’ll still pay more for your home over time.
You want to tap into your home’s equity and take cash out.
Hopefully, your home’s value has increased since you bought it. If so, you could be sitting on a pile of equity that you could turn into cash. That dough could be used to:
- Tackle a major home repair, like installing a new roof
- Upgrade (finally!) to the dream kitchen you’ve been wanting
- Pay off high-interest credit cards or other debts
- Renovate or purchase an investment property or a second home
- Cover a large medical expense that your insurance doesn’t pay for
- Pay for college expenses that aren’t covered by financial aid or tax-advantaged college savings accounts
All you need to do is refinance your mortgage.
Essentially, when you refinance and pull out cash you’re borrowing against your equity. It’s kind of like taking out a home equity loan or line of credit. But when you refinance, you get a brand-new mortgage and cash in hand, along with a new interest rate and repayment term.
Your credit score has improved and you may qualify for a lower rate.
Credit scores are one of the main factors lenders look at when you apply for a mortgage. Your score carries a lot of weight when it comes to determining the rate you qualify for.
If your credit score wasn’t high enough to lock in the best rate the first time around, refinancing could be good for your bottom dollar now — especially if you’ve been working hard to improve your score. Boosting it 100 points could mean as much as a 1percent difference in your rate, but even a smaller bump could save you some serious money.
Crunch the numbers carefully.
By now, you know why you might want to refinance. But how do you know if it makes financial sense?
Whether you should refinance depends on several factors, including:
- How long you’ve owned your home
- How much you initially borrowed
- How much is the outstanding portion of your loan
- Your current interest rate
- The loan term you want to refinance into
- Whether you plan to pull cash out
- Your credit history and score
- How long you plan to stay in the home
Refinancing is really a numbers game. In the end, it’s all about how much you can save.
If you’re not sure how to put it all together, you can use Ally’s Refinance Calculator to help compare your options and decide whether now is the right time to refinance. You can adjust the loan term to see what kind of payment you might end up with, how much you could save each month and what your mortgage will cost altogether.
Own a home and save money at the same time? That’s a better version of the American Dream.