Planning to refinance? Here’s what to consider
Many people refinance their home loans to lower their monthly mortgage payments. Others want to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. If you are planning to refinance for one of these reasons, take a look at some of the details.
Start with closing costs
Any time you refinance, you’re responsible for paying closing costs, which can be 2 to 5 percent of the amount of your new loan.
When thinking about closing costs, it can be helpful to calculate your break- even point. This is how long it takes for the reduction in your monthly mortgage payments to equal the cost of refinancing. If you believe you might sell your home before you reach the break-even point, you may want to rethink refinancing.
Refinancing to lower your monthly payment
You may be able to lower your monthly payments by extending the length of time over which you pay your mortgage. It’s common to refinance to a new mortgage of the same term, typically another 30-year mortgage. This means you’d start a new 30-year mortgage after already owning your home for a number of years. Keep in mind, if your rate remains the same, this extended period means you’ll pay more in interest over the life of the loan.
You may be able to lessen the additional interest you pay by refinancing at a lower rate. In fact, if you’ve had your home for a short period, you may be able to save on interest in the long term. You can generally secure a lower rate if market interest rates fall or you’ve improved your own finances. A higher credit score, less debt and more home equity can help you qualify for lower rates.
Refinancing to a fixed rate
The general rule of thumb is that refinancing to a fixed-rate loan makes the most sense when interest rates are low.
ARMs generally have lower starting rates than comparable fixed-rate mortgages. However, after the initial fixed-rate period of an ARM expires, the interest rate may change based on market conditions. While no one can predict whether rates will rise or fall in the future, many homeowners are taking advantage of recent low rates to refinance to fixed-rate mortgages.
Fixed-rate loans offer stability; your payments of principal and interest stay the same through the life of your loan. This means you don’t pay more if market interest rates increase; however, you may miss out on lower payments if market interest rates drop.
If you’re considering refinancing, it’s important to know that some mortgages have prepayment penalties. These penalties are noted in your original mortgage contract.
Weigh the pros and cons
With all the factors that go into a refinancing decision, it can seem overwhelming. Consider using an online calculator to help you with the math on your break-even point, new monthly payment and lifetime savings (or additional interest). Bank of America’s refinance calculator can give you quick, custom rates.
Keep in mind, if you decide to refinance your home loan, you may be able to make other changes to your loan at the same time, such as borrowing against a portion of your available equity. Talk to your lender about what you’d like to accomplish and see what’s possible in your situation.
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