In “The Pros and Cons of Refinancing,” we took a look at the benefits of refinancing and examined the potential costs. When it comes to determining the right time for that first refinance, here are the conditions to you’ll want to consider:
- Type of mortgage – If you have an adjustable rate mortgage with a 5, 7, or 10-year adjustment period — that is, the time in which your initial low rate remains unchanged — you’ll want to consider refinancing to a fixed-rate mortgage before that period ends. This will guarantee you a fixed monthly payment and a stable cashflow. If you already have a fixed rate, proceed to number two.
- Current interest rate – In order to make refinancing work for you over time, you’ll want a market rate that is at minimum .75 basis points lower than your current rate. So the better the interest rate, the sooner you’ll be able to recoup the cost of refinancing. Your lender may allow you to roll some or all of those costs into your new loan. Just keep in mind, depending on the terms of payment you choose, this may add to your monthly payment and increase the amount of interest you’ll pay over time.
- Equity – When you refinance, you do so using the equity you’ve accumulated in your home. Equity is determined by subtracting the amount owed from the value of the home. So, if your home is currently valued at $300,000 and your remaining balance is $120,000, you have $180,000 or 80% of your home’s value in equity. Your equity position grows as you make payments on the principle of your mortgage loan. Your equity also increases if the value of your home has risen. Note: Current market conditions indicate a significant rise in the value of single family homes. Refinancing based on a considerable increase may also allow you to eliminate mortgage insurance (MI) provided your loan-to-value is 80% or less.
- Credit score – Before you decide to refinance be sure you’re credit rating is as good as possible. The better your credit score, the better the interest rate.
- Cost of refinancing – Unless you roll the costs to refinance into your loan, refinancing will require cash upfront. These costs may include: the appraisal fee, lender fees charged for application processing and recording fee, and an origination fee to cover the lender’s overhead costs. Other applicable costs include “discount points” used to “buy” a lower interest rate and any prepayment penalty or balloon payment needed to pay off your original loan.
- Your next move – In order to cover the cost of refinancing you’ll need to plan on staying in your home longer. Your loan officer can help you determine the amount of time it will take to break even on your refinance.
The reasons and benefits of refinancing are many but identifying the appropriate conditions for doing so, particularly the first time, require the right mix of current market conditions, your financial situation, and future plans.