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When Does It Make Sense to Refinance?

refinancing your mortgage can help you dedicate more time to the things you love, like dinner with your family

With interest rates at historical lows right now, mortgage interest rates are holding steady, too. So it may make sense to refinance – get a new home loan and pay off the old one.

There are several things to look into and factors to consider before you decide, but it boils down to this: Will refinancing save you money?

Basically, there are three questions to ask yourself to see if you can save money by refinancing:

  1. Are mortgage interest rates lower than when I got my home loan?
  2. Has my credit score improved since I got my current mortgage?
  3. Is my home worth more now than when I got my existing mortgage?

A “yes” to any or all of these show that it could be a good time to refinance!

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Benefits of refinancing

One benefit of refinancing is to get more favorable loan terms than you have currently.

With a lower interest rate on the same loan amount as your existing mortgage, your monthly payments will be lower. Or, if you’ve paid down the loan over time and can refinance to a smaller loan – with the same or lower interest rate than you have now – you also can lower your monthly payments. A better credit score will improve the interest rate you can get.

Another benefit of refinancing is to use the equity in your home to get cash out.

If your home has increased in value since you got your current mortgage (and with today’s historically low interest rates), you may be able to refinance for the same or larger loan amount than before. If you qualify, a cash-out refi allows you to get a new home loan plus cash at closing from the equity in your home. This could let you pay off high-interest debt (like credit card debt), make home improvements, or pay for a child’s tuition.

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Loan terms to Look at When Refinancing

Loan Duration

You can change your loan duration with a refinance, shortening or lengthening the new term of the loan. Here are some different types of home loans.

15 vs. 30 Year

A fixed-rate mortgage has a predictable monthly payment for the life of the loan. The duration of the loan impacts monthly payments, amount of interest paid, amount of time it takes to build equity in the home, and the length of time it takes to pay off the loan.

15-year and 30-year mortgages are the most typical lengths of fixed-rate mortgages:

  • A 15-year mortgage will have higher monthly payments than a 30-year mortgage, but the upside is paying less interest over the life of the loan. You’ll build equity in your home faster and pay off the mortgage sooner, too. For instance, if you’re now entering what’s considered peak earning years (ages late-40s to late-50s) and can handle higher monthly payments, it may make sense to refinance to a 15-year loan to pay off your home before you retire.
  • A 30-year mortgage has lower monthly payments than a 15-year mortgage because they are spread out longer. You will pay more interest and take longer to build equity and pay off the mortgage than with a loan of shorter duration. People often choose a 30-year mortgage for the monthly affordability. Lower payments also may create a sense of security in the long-term financial ability to handle the ups and downs of life without losing one’s home.

Adjustable-rate Mortgage

Home loans can have adjustable-rate mortgages, too. Depending on the terms, this type of loan will have a fixed interest rate for a short period of time – 1, 5, 7, or even 10 years – before the rate adjusts higher or lower to current interest rates of the time.

A featured rate early in the loan term can let borrowers buy more expensive homes than would be affordable with a fixed-rate loan. The loan can be a budget-buster, however, if interest rates rise significantly, and may require a homeowner to refinance when the rate adjusts.

Balloon Mortgage

A balloon mortgage with its low monthly payments may entice a borrower to qualify for a bigger loan and a more expensive house than they thought possible. Buyer beware.

A balloon mortgage is for a shorter loan duration than traditional mortgages and consists of nearly interest-only monthly payments. At the end of the loan term, the entire mortgage becomes due in a big “balloon payment.” Because this loan doesn’t amortize (pay off the principal amount over the life of the loan), a borrower won’t build much equity in the property or pay down the loan.

A balloon mortgage is usually a short-term solution. Because this type of loan is so risky, many people need to refinance their balloon mortgage before it comes due.

FHA Loan Refinancing

If you have an FHA home loan you are allowed to refinance to lower your monthly payments. An FHA Streamline refinance is a way to fast-track a new loan and still retain the same FHA-qualifying, low-interest benefit. The guidelines strictly limit what you can get from the refinancing, and there are some costs involved as with any new loan.

Things to consider about refinancing

As a rule, you have to wait six months after you’ve gotten a mortgage to refinance. And interest rates aren’t the only factor in refinancing – there are costs to getting a loan. You’ll go through many of the same processes for refinancing that you went through the first time you got a mortgage, including fees and closing costs.

Here’s a formula for figuring out if the costs of refinancing are worth it.

Break-even Point: When Cost = Savings

If you’re going to spend money to save money, you’ll want to find your break-even point – the point in time or loan payments when cost = savings. Once you pass that break-even point, you actually start saving.

The formula is: Loan Costs divided by Monthly Savings equals Number of Months to break even. Here’s an example. If you refinance to save $150 each month on mortgage payments, and you pay $3000 in fees/closing costs to get the new loan, it will take you 20 months to break even (3000/150=20). So, as long as you plan to stay in your home at least two years (24 months), you’ll be saving money by refinancing. If not, then refinancing might not be the right step.

As always, every individual homebuyer’s situation is different and it’s best to talk it over with an expert. If you think you want to refinance your home loan, contact Capital Bank to speak to a knowledgeable, experienced loan originator.

What Do I Need to Refinance?

Are you ready to refinance your mortgage? Here are the documents a new lender will ask to see:

  • Proof of income: paystubs, two years of tax returns, W-2/1099 forms
  • Proof of assets: home ownership documents and current home value, bank accounts, investment /retirement accounts
  • Credit report
  • Statements of debt: credit card statements, school and car loans, other outstanding loans/debt
  • Current mortgage statement

Home Refinance FAQs

Does refinancing hurt my credit?

According to credit bureau Experian, refinancing can temporarily lower your credit score because of credit checks, multiple loan applications, and closing your old mortgage account. One hint: make sure all loan applications are within a 45-day period to count as one credit inquiry. Your score will go up again as you make regular on-time payments on the new loan.

How do mortgage points work?

A lender may offer you the chance to lower the interest rate on your loan by paying mortgage points, each worth 1% of the amount you borrow. Buying points will increase your closing costs but may save you money in the long run by reducing your monthly payments. You can do the math here.

What is a cash-out refinance?

A cash-out refinance is when you get a larger loan than your old home loan. The difference between the two loans comes back to you as a cash payment.

What is a cash-in refinance?

A cash-in refinance is when a borrower brings money to the table to lower their current mortgage amount owed. This can be to avoid mortgage insurance on the new loan, get a lower interest rate, or even to qualify for the refinance.

Can I refinance a VA loan?

The U.S. Department of Veterans Affairs allows a VA-backed home loan refinance to reduce monthly payments or make payments more stable (e.g., replacing an adjustable-rate mortgage with a fixed-interest one). Applicants have to meet certain eligibility and loan requirements.

* Capital Bank, N.A. is not a debt management, tax planning, financial planning or credit counseling service provider. The information provided is strictly for informational purposes and not meant as legal or financial advice. Please seek professional advice from an accountant, financial advisor or credit counselor.

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