This week’s blog post in our “Financial Planter” series is written by Chonce Maddox, a Financial Services Professional.*
Getting a mortgage is a major financial milestone.
While most mortgage rates are lower than other forms of debt, a mortgage is usually long term.
Many homeowners will spend fifteen years to three decades paying off their homes. As years pass, things change. The value of your home might increase, interest rates will change, your credit score might improve, and maybe you will earn more money. As these changes occur, they may signal that it’s time to consider refinancing your mortgage.
Maybe you've been making payments on your home for a while and you notice the market's interest rates have dropped quite a bit. You might want to take advantage of this lower rate. Having a lower interest rate often means you’ll pay less in interest now and over time. A lower interest rate allows more of your monthly payment to go towards the principal balance rather than the interest, enabling you to pay off your mortgage in a shorter period of time.
So when is the best time to refinance your mortgage? The following signs may indicate the ideal time for you:
You Want to Lower Your Rate or Change Your Term
If you initially choose a long-term mortgage but interest rates have dropped, you may be able to refinance and cut your term in half without increasing your monthly mortgage payment by a significant amount.
You can even obtain a bi-weekly mortgage and make one-half payment every other week instead of the usual full payment every month. According to The Mortgage Reports, bi-weekly mortgage payments can shorten your loan term by approximately 4-6 years given today’s mortgage rates. This means you'll pay off your home faster.
Your Credit Score Has Increased
Credit score is a huge factor when determining the conditions and terms of your mortgage. People with excellent credit scores are in a better position to get a lower mortgage rate. If your score was average when you obtained your mortgage but has since increased, this could be a good time to refinance your mortgage.
For couples who buy a home together, both applicants should focus on increasing their credit score whenever possible to be in a better position to refinance later down the line. You should know that lenders usually take the person with the lowest credit score into account when determining the terms of your mortgage.
You Want to Change From an Adjustable-Rate Mortgage to a Fixed-Rate Mortgage
Adjustable-rate mortgages (ARMs) may be appealing to prospective homeowners due to the initial low-interest rates. However, they can change periodically, making mortgage rates inconsistent. If your mortgage keeps changing every few months or even every year, it can affect your entire budget.
Fixed-rate mortgages (FRMs) have interest rates that are a bit higher than ARMs but they are consistent and less risky. Interest rates won't stay low forever; homeowners with an ARM might very well want to lock in a fixed interest rate by refinancing their mortgage.
You Want to Tap Equity in Your Home
If your home is worth more than your current mortgage balance, then you have built up equity in your home. The amount of equity will depend on the total amount paid on your mortgage thus far. This equity indicates a higher level of financial stability for you.
You can refinance your mortgage and cash out the equity you have. You also have the option available to take out a home equity loan or a home equity line of credit (HELOC), if you decide that is what you prefer. However, the benefit of refinancing your mortgage and cashing out the equity you have is that your mortgage will be restructured allowing you to continue to have one loan instead of a mortgage and an equity loan. Be aware that the housing market fluctuates up and down. If your home value was to decrease, it could fall to a point where your mortgage is higher than the value of your home. You become “underwater” – meaning you owe more than your house is worth.
If you need money for home improvement projects, to pay off debt, or to cover another expense, this would be a great option if you have equity in your home.
You Can Potentially Stop Paying Mortgage Insurance
Private mortgage insurance, commonly referred to as PMI, allows homeowners to buy a house with less money down and also encourages lenders to issue loans with smaller down payments.
It's not a win-win situation for everyone though. PMI can add up over time and cost homeowners thousands of dollars throughout their mortgage term. If your down payment was not at least 20 percent of the cost of the home when you first obtained your mortgage, you may be able to drop PMI once you have built up enough equity in your home by refinancing your mortgage.
In conclusion, refinancing can be a great financial move when done at the right time. It can help lower your interest rate, cash out equity, and even free up more of your income to pay off other debts or to save and invest.
However, you must consider your potential gain from refinancing along with your credit score to determine if it is the best time to make the decision. Refinancing often involves fees like closing costs so the savings you generate or the money you receive from cashing out must be higher than the cost in order to make it an ideal financial move.
Chonce Maddox is a personal finance journalist who is passionate about helping others achieve financial stability and wellness. She chronicles her financial journey that is filled with aggressive debt payoff, frugal parenting, and maintaining motivation throughout life on her blog, mydebtepiphany.com. You can follow her on Twitter or check her out on Facebook.
All content provided in this blog is supplied by Chonce Maddox and is for informational purposes only. Barclaycard makes no representations as to the accuracy or completeness of any information contained in the blog or found by following any link within this blog.