Refinance Your Mortgage: When and How To Do It

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Nobody loves making mortgage payments, but yours makes you especially sick because you’re locked into an interest rate much higher than the current rates you see advertised everywhere. Trying to refinance your mortgage could help you save money if that’s the case.

Refinancing your mortgage involves obtaining new (and more appealing!) mortgage terms to replace your existing ones. It could be with the same lender or a new financial institution.

Though it’s not for everybody, refinancing is a valuable tool in the right home ownership situations. Here’s what you should know before you dive in.

Secure a Lower Interest Rate

The leading reason to refinance your mortgage is to secure a lower interest rate than your current one. As long as you can reduce your interest rate by a minimum of 1% to 2%, the savings will pay off in the long run.

Locking at a lower interest rate carries significant benefits. There’s the first and most obvious benefit of saving money: If you lower your interest rate from 9% to 4.5% on a $100,000 mortgage on a 30-year term, your monthly mortgage payment drops from $804 to $506! That’s a full $300 a month in savings. Just imagine the breathing room that it creates.

A lower interest rate also saves you money over time since you will pay less toward interest overall. Some homeowners can save tens of thousands of dollars on interest payments by refinancing. This has a secondary effect of making it easier to pay off your mortgage early and build equity more quickly.

Let’s use the same example of a $100,000 mortgage dropping from 9% interest to 4.5% interest. If you continued to pay your habitual $804, even after your monthly amount decreased to $506, you could add that $300 every month towards the loan principal and pay off your entire loan at an accelerated rate.

Shorten the Term of Your Mortgage

A second benefit to refinancing is getting a shorter loan term—a loan fully due sooner. The lower and more manageable interest rates offered through refinancing make committing to a shorter loan term easier. Lenders are more likely to award low-interest rates to homeowners who take shorter loans because lenders are eager to get their money back quickly.

By securing a lower interest rate while still paying the same amount each month, you can cut your 30-year mortgage into a 15-year one. In other words, you could own your home free and clear more than a decade earlier than planned! That gives you equity to leverage and freedom from debt you didn’t expect.

Should I Refinance My Mortgage?

There’s no quick yes or no answer to this question, but the simple math of your costs compared to your savings can help you make an informed decision.

Don’t just look at the nominal interest rates and loan terms when doing the math. Be sure to examine the closing costs and any other fees associated with refinancing. They do add up and affect the actual cost of your new rates.

Refinancing can cost between 3% and 6% of your principal balance. If you still owe $200,000 on your house, you could have to pay as much as $12,000 to refinance. Don’t commit to refinancing unless you feel confident that you’ll live in your home long enough to recoup that $12,000 and much more beyond it. Otherwise, you’ll break even or possibly even lose money on your refinancing efforts.

That’s why we said at the beginning that prevailing interest rates should be several percentage points lower than what you’re paying now to make the deal worthwhile: You want to make sure you’ll be getting a better rate at the end of the day, even figuring in the cost of all the fees.

However, as long as you save a significant amount of money, enjoy lower monthly mortgage payments, or pay off your mortgage years early, refinancing could be a valuable financial choice for you and your family.

Don’t wait to get out of debt! Read this: A Complete, Step-By-Step Guide to Get Out of Debt.