If you’re a homeowner, you know that property ownership comes with its upsides as well as its challenges. While owning a home is generally regarded as a sound financial decision that allows you to build equity and diversify your investments, mortgage payments can be expensive, especially when considering the other expenses of homeownership.
Just about every homeowner faces the decision to refinance their mortgage at least once during their loan. But what does refinancing really mean? And is it a good idea for you and your family? Refinancing a mortgage can be a great idea in some situations but shouldn’t be viewed as a cure-all way to lower your mortgage payment. A few basic facts about refinancing will help you decide if this is the right step for you.
At its most basic, refinancing is replacing your existing mortgage with a new one. This means you will probably get a loan with a new term and a new interest rate. That’s why many people choose to refinance when interest rates are low—they want to take advantage of market conditions to pay less toward interest on their loans.
As with all financial decisions, refinancing a mortgage depends on your situation, and you should always discuss it with a trusted financial professional. But generally speaking, it can be a good idea to refinance when interest rates are low if you have a fair amount of equity in your home, if your credit score has improved, or if property values have gone up.
Refinancing costs vary based several factors, but in general, they can cost between 3% and 6% of the loan’s principal. In addition, an appraisal and title search are required, and closing costs and application fees will apply. Make sure that your potential savings are greater than these costs to ensure you’re really saving money.
What Are the Risks of Refinancing?
Refinancing can save you money or provide you with cash to invest in home improvements, but there are some risks. For example, as with an original mortgage, you must pay closing costs on a refinance, which can sometimes reach thousands of dollars. Pay attention to these costs relative to your expected savings to see if the financial reward is worth it.
In general, you should try to get a locked-in rate of 1-2% lower than your existing interest rate to make refinancing worth it. Additionally, the value of your home should have increased recently as a lower appraisal could negatively impact the terms and rates lenders offer you. A good rule of thumb is that your home should be worth more than you owe on your existing mortgage.
Many homeowners use a common tax deduction called the mortgage interest deduction, which allows them to reduce their federal income tax bill. If you reduce the amount of interest you pay, your deduction will shrink as well. At the same time, if you increase the size of your loan by taking out cash, for example, your total interest amount will be greater. Carefully consider your situation before you make any decisions.
Refinancing can be a great way to lower your costs and access more money to perform renovations or invest in other ways. But it’s critical to remember that refinancing should depend on your individual financial situation more than market conditions. Carefully consider all of the factors and options before you commit to refinancing to ensure that it is the right choice for you.