When You Should Refinance Your Home


Source: woodleywonderworks.

With the U.S. economy on the road to recovery and interest rates on the rise, many people have already taken advantage of low rates to refinance their mortgages. Yet there still remains time for those people who haven't taken advantage of the low rates to refinance their homes -- and knowing both why and when you should consider refinancing is essential.

Many people have announced the truth of "historically low interest rates," and while rates have risen from the lows seen last year, the reality remains that the 4.5% 30-year fixed mortgage rate is still incredibly low in the grand scheme of things. Consider that from 1976 to July 2010, there was never once a time when rates were as low as they are today. Even if you don't own your home, having a foundational understanding of the refinancing process is essential.

Why you should refinance
Put simply: Refinancing a mortgage can be a wildly effective way to save money.

Consider that if someone had a $200,000 mortgage at 6%, their monthly payment would be almost $1,200 a month. Yet if they were able to refinance at the prevailing market rate of 4.5%, their monthly payment would be cut by almost $200 to $1,015. The savings over a 10-year period would be nearly $23,000. Even if their rate was cut by 0.5%, the 10-year savings stand at more than $7,500.

Yet the thing about refinancing is that it may allow you to move from a traditional 30-year mortgage to a shorter 15-year mortgage, while not having your monthly payment rise significantly. Going to the same example of a $200,000 30-year mortgage at 6%, with a monthly payment of $1,200, if the home was refinanced to a 15-year mortgage at 3.5% (the rate today), the payment would rise by $230 a month.

Although the monthly payment would rise, the savings over the lifetime of the loan would be monumental:

Certainly an increase of $230 a month is nothing to scoff at, but if it meant a total savings of almost $175,000, it would certainly be tough to argue against.

While at first glance the difference between a 6% and 4.5% -- or even 3.5% -- rate doesn't seem all that significant, you can see that over the course of owning a home, refinancing to a lower rate could have an astounding effect on your wallet.

When you should refinance
Of course there may be certain times and reasons to not refinance a home even if it results in a lower mortgage payment, especially for people who have been in their homes for longer periods of times (remember that with each monthly payment, the total interest paid goes down) or those people who don't intended to stay in their homes for more than a few more years.

This is because there are fees that correspond wtih refinancing, including the loan origination fee, document, application, and appraisal fees. In addition, a lender may offer the borrower an ability to pay "points," which are fees paid upfront to reduce the interest on the loan, or a mortgage may have a pre-payment penalty, which is a certain charge for paying off the loan early.

Yet after doing the diligent research to figure out what your total fees will be, the Federal Reserve notes fees can range from 3%-6% of the principal value of the home. If you find yourself in a position where you anticipate you'll be in the home longer than it takes to recoup those fees through the monthly savings, refinancing can be a great move.

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