Interest rates have begun inching up -- and are likely to continue doing so. It's thus a good time to ink a mortgage at favorable rates, or to refinance an existing loan. If you're not convinced, here are three reasons why you might want to refinance your mortgage.
What is refinancing?
Refinancing is when you essentially trade in your current mortgage for a newer one ideally one with more attractive terms. The first loan gets paid off by the new one.
The main reason that most folks refinance a mortgage is to take advantage of a lower interest rate and thereby end up with smaller monthly payments. But that's not the only possible reason. You might refinance a 30-year loan into a 15-year one, ending up with larger payments, but fewer of them and less total interest to pay. Here's a review of these and other reasons to refinance your home loan.
Interest rates are rising, so lock in a lower rate to save money
Everyone knows that lower interest rates mean lower payments, but many people might not realize just how much of a difference a lower rate can make. Check out the table below, reflecting payments for various interest rates for a $200,000 30-year fixed-rate mortgage:
Interest Rate | Monthly Payment | Annual Cost | Cost Over 30 Years |
|---|
3.5% | $898 | $10,776 | $323,280 |
4% | $955 | $11,460 | $343,800 |
4.5% | $1,013 | $12,156 | $364,468 |
5% | $1,074 | $12,888 | $386,640 |
5.5% | $1,136 | $13,632 | $408,960 |
6.00% | $1,199 | $14,388 | $431,640 |
If you can lock in an interest rate that's a percentage point lower than what you have, you may be able to save $40,000 or so over 30 years. (Note that when you go through the pre-approval process, you can probably find out exactly how much you can save.)
Your credit score has improved
If your credit score has improved considerably in recent years, you may now qualify for a significantly lower mortgage interest rate -- even if overall rates have been rising. Low credit scores keep home buyers from being offered great interest rates. Check out the table below, which shows what a difference a strong credit score can make, using the same mortgage example as above:
FICO Score | APR | Monthly Payment | Total Interest Paid |
|---|
760-850 | 3.879% | $941 | $138,735 |
700-759 | 4.101% | $967 | $147,945 |
680-699 | 4.278% | $987 | $155,378 |
660-679 | 4.492% | $1,012 | $164,471 |
640-659 | 4.922% | $1,064 | $183,087 |
620-639 | 5.468% | $1,132 | $207,364 |
If you're currently carrying a mortgage at a high rate, consider spending the next few months or the year ahead increasing your credit score so that you might refinance at a lower rate. Some ways to improve your credit score include paying bills on time and paying off a lot of debt in order to lower your debt-to-available-credit ratio.Lenders like to see you owing only about 10% to 30% of the sum of all your credit limits, because it suggests that you have your debt under control and can afford to take on some more debt via the mortgage you're seeking. You can get free copies of your credit reports once a year from each of the main credit reporting agencies -- do so and correct any errors on them.
You might want a different kind of mortgage
Another good reason to refinance is if a different kind of mortgage makes sense for you now. For example, if you started out with an adjustable-rate mortgage (ARM), you may be facing gradually increasing interest rates over the coming years -- which will be costing you more and more. You could refinance into a fixed-rate loan, locking in a low rate. (Even today's increased rates are historically very low.)
Alternatively, you might switch from a 30-year fixed-rate loan into a 15-year fixed-rate loan, in order to pay the loan off sooner and pay much less in interest. It will likely entail higher monthly payments, though, so be sure you can swing those. (A good alternative is to keep the 30-year loan and just make extra payments regularly, in order to shrink the principal.) If your current loan's monthly payments are too steep for you (which might be the case if you have a 15-year mortgage now), you might refinance into a fresh 30-year loan for the lower payments. Just know that that will be costing you a lot in interest over the long run, and entering retirement with mortgage payments is not ideal.