For many Americans, a home mortgage is a financial long-term relationship. But how do you know when it’s time to refinance your biggest investment? Homeowners have a lot of reasons to refinance. Maybe they’d like a lower interest rate, or to shorten the term of the mortgage. Homeowners may also want to switch from a variable interest rate to a fixed rate mortgage, or they’d like to tap into their home’s equity to finance a large purchase or home improvements. Other homeowners use the equity in their home to consolidate debt.
But when is it time to refinance your mortgage?
First, it’s important to know that refinancing comes with a cost, as much as 3 to 6 percent of your loan’s principal. The lender often requires appraisal, a title search, and fees.
Here are six questions to ask yourself before you refinance your home:
1. Start with this question: With the cost of refinancing, including fees and appraisal, is it a benefit to refinance at this time?
2. Can I get a lower rate, and what does that mean for my mortgage? One of the most common reasons to refinance a mortgage is to score a lower interest rate on your existing loan. If you can get a rate reduction of 1 percent or more, it could be worth refinancing your mortgage. Anything less may not be worth the costs of the refinance. Of course refinancing helps you save money, but it can also help you build equity faster and possibly decrease your monthly payment.
3. Where does my mortgage fit into my long-term financial plan? Refinancing your mortgage can give you the opportunity to shorten the term of your loan without a huge change in your monthly payment. If paying off your home before retirement, sending a child to college or other life milestone is in your long-term financial plan, refinancing may make sense for you.
4. Am I comfortable with the terms of my existing mortgage? Adjustable rate loans usually start out with lower rates than fixed-rate mortgages, but fluctuations and adjustments can cause increases that are higher than fixed-rate loans.
5. Am I ready to tap into my home’s equity? A home equity loan is a great tool to finance bigger purchases or consolidate debt. Pulling the equity from your home to cover major expenses is a decision a homeowner should make with their financial planner. Be sure to consider all other financial products and loans before you look to your home equity as a funding source, as you could be adding years of payment to your mortgage.
6. Should I refinance to consolidate debt? This is a tricky question, and the answer requires a lot of inner reflection. Many homeowners refinance to consolidate debt, and on paper, it can make sense. Trading a high-interest debt like a credit card balance with a low-interest mortgage is tempting, but it only makes sense if you know you can control your spending going forward and commit to overall debt reduction. If you continue to rack up debt after a consolidation, you are going down a slippery slope of lost home equity, longer repayment on your home loan with increased interest payments and more high-interest debt if you don’t control spending. Debt consolidation by home equity only works if you are committed to breaking the debt cycle once and for all.