Today’s blog is about really thinking things through before going forward with a refinance.
I recently got asked by a new homeowner whether refinancing the mortgage in a couple of years would be a good idea. My short answer was “make sure that the benefits out-weigh the cost of the refinance.” Below points were included in my long descriptive answer of “why” behind my short answer:
- The after-purchase-costs: Some homeowners want to save on the interest they’ll pay the lender by getting a 15-year mortgage instead of a 30-year mortgage. Some of them underestimate a series of purchases which I’ll call “after-purchase-costs” that follow the purchase of the home. Some of the big ticket items are property taxes, insurance, and furniture, and some small ones are home owner’s association dues, utility bills, lawn maintenance, etc. Unless one has a good disposable income stashed somewhere, these after-purchase-costs will be credit purchases thus resulting in monthly payments.
- The plan: If the homeowner plans to sell the home in a few years, the refinance might not be worth it as he’ll lose a good chunk of change – about 4-5% of the loan – in closing the refinance. The homeowner should also consider how long he will have to stay in the home after the refinance in order to recoup the refinance costs.
- The equity: In order to refinance the loan, the home must have at least a 20% equity without paying mortgage insurance.
- The market: If the price of the home increased in the last few years, a refinance might be worth it. Thanks to the increase in the home value, the homeowner might be able to do a cash-out refinance where he gets some money out of the refinance.
- The loan type: If the homeowner has an adjustable rate mortgage (ARM), it might be worth it to switch over to a long term fixed-rate mortgage.
- The interest rate: Was there a significant improvement in the homeowner’s credit score since the purchase which will result in a significantly lower interest rate? If so, refinancing the loan might be worth it. But, does the saving due to the lower interest rate supersede the cost of the refinance? If not, it will be better to keep the same interest rate but make additional monthly principal payments.
- The driver: Whether or not to do a refinance has a lot to do with why to do a refinance – to lower the monthly mortgage payment, to take the equity out of the home, or to lower the interest rate? Sometimes, the homeowner can rob Peter to pay Paul and keep the mortgage intact to accomplish his overall financial goals.
There you have it – the different factors to consider before refinancing your home.
Unlike when buying a house, there is no realtor involved since you’re not buying the house. However, every time you do a refinance, there are closing costs involved. The closing costs can be rolled into the loan. But, it’s crucial that you compare the benefits and costs to ensure the benefits outweigh the costs of the refinance.
Here at Successful REI, LLC, we buy, sell and invest in single-family residential homes. Please, let us be the first people you call for your real estate needs.