You hear that interest rates are dropping so you assume you should refinance. What if it’s not the right time, though? Before you just assume that you should consider refinancing, you should know when it is the right time and when it might be best to wait.
Will You Save Money?
First, you must ask yourself if you will save money. Just how much money you need to save is a personal decision. What you consider adequate savings the next person might not think that it is enough. Compare your current payment to the potential payment after refinancing to determine if you should take the new loan.
For example, will you save $20? If so, it’s probably not worth refinancing. Don’t forget that you have to pay closing costs each time you refinance. Is paying several thousand dollars really worth saving just $20 a month? It’s probably not the best idea. On the other hand, if you’ll save $200, it might be worth the expense of refinancing.
What’s Your Break-Even Point?
Your break-even point occurs when you pay off your closing costs with the savings you reap from the refinance. For example, if you save $50 per month and it costs you $3,000 to refinance, it would take you 60 months to pay off the closing costs and start realizing the savings.
Just what is the right break-even point? It depends on your situation. For some people a 2-year break-even point is best, especially if they knew they will move from the home in the next 5 years or so. Other people that know they will stay in the home for the long run may be able to take advantage of a longer break-even point.
You can figure out your break-even point with the following equation:
Total closing costs/monthly savings = months to breakeven
Is Your Rate Going to Adjust?
If you have an adjustable rate on your mortgage and it’s about to adjust, it may be time to refinance. Because there’s no way to predict what interest rates will do when it’s time for your adjustment, it may be a good idea to get a fixed rate now.
If you have increased your credit score, lowered your debt ratio, or have more equity in the home now than you did when you bought it, you could be in good shape to get a fixed rate loan at a decent interest rate. Try applying for the fixed rate loan and see how it compares to your teaser rate on your adjustable rate loan. Don’t forget that your ARM can adjust every year, not just once, which can really leave you with a high interest rate down the road.
Do You Qualify?
Refinancing won’t make sense if you can’t get the best rates possible. Before you apply, figure out what shape your financial life is in at the time. Do you have a higher credit score than when you bought your home? Is your debt ratio about the same or have you overextended yourself? Are your income and employment stable?
If you have any ‘iffy’ qualifying factors, you may not get the best interest rate possible, which may negate the benefits of refinancing. If you don’t have good qualifying factors, it may pay to figure out what you need to improve in order to ensure that you have the best chance at a great interest rate.
Only you will be able to tell if it makes sense to refinance. Weigh all of your options to make sure you get the best loan available to you. Take the time to compare it to your current loan to make sure there are adequate savings even after you pay the closing costs.