If you’re like most people, your mortgage is probably the definition of “set it and forget it,” right?
Since consumers get mortgages that run for 15 or 30 years, you may be conditioned to think that refinancing is a rare event. But is it? Today’s blog breaks down what refinancing is, why, how, and when people do it, and the considerations involved in determining whether refinancing is right for you.
Are you confused that you’re reading about refinancing on the blog of an online insurance marketplace? You shouldn’t be. Here at Covered, we don’t JUST think about insurance. We know there’s a much bigger picture behind your need for insurance. You have people you care about. Stuff you’ve invested in, like your car, your home, and your education. Insurance only matters because all of that matters. Which is why we’re taking the time today to talk to you about… your home mortgage, and whether it may be worth refinancing.
What Is Refinancing?
Refinancing involves paying off your old mortgage and transferring that debt to another lender. It also includes fees to cover appraisals and processing, which can cost up to 6% of the principal. So there’s definitely a cost in the short term, but there are still valid reasons for refinancing. The trick is to weigh the costs versus the benefits.
Why Do People Refinance?
The biggest reason people refinance? Interest rates, of course. Interest rates that mean saving money in the short or long term, or maybe being able to pay off your mortgage more quickly.
As rates have dropped, many Americans have refinanced to lower their mortgage payments. In fact, nowadays — compared to just 20 years ago, when rates weren’t nearly as favorable — you could conceivably switch from a 30-year mortgage to a 15-year one and actually end up paying less per month. Even if you’re not paying less monthly, chances are that your monthly payment won’t go up much. Besides, a lower interest rate means you’re able to pay more towards the principal, which helps you build equity faster. It’s a classic win-win. In other words, if you can save even 1% on your current rate, it’s probably worth it.
Wait, I Have to Understand Interest Rates?
Fortunately, interest rates aren’t hard to understand. There are adjustable rate mortgages (ARMs) and fixed-rate ones.
Generally speaking, if you’re looking at staying in your house for a long time and want to finance more than 15 years, it’s a good idea to lock down low rates while they last. However, if you think you might move in a few years (maybe yours is a starter home?) you may want to consider an ARM. The short-term gain of lower payments could be worth it.
What About a HELOC? Is That a Good Idea for Me?
As many Americans continue swimming not-so-gleefully in debt, an increasingly popular option is to leverage the equity in their homes for a line of credit, or to refinance and consolidate their debt. A home equity line of credit, or HELOC, is often a good idea if you’re able to put all of those debts in one place that has a lower interest rate — and keep it there!
That’s the key: keeping it there. Sadly, too many people are tempted by the “fresh slate” of a paid-off credit card. They often succumb to racking up purchases right after consolidating debt with a refinance or a HELOC. This tremendously slippery slope can ultimately lead to bankruptcy. So if you’re consolidating debt because you had a problem before, make sure you’ve tackled your spending-side issues before bringing your home into the equation.
Is Refinancing Right for Me?
To most people, buying a house is far more than just a purchase. It means creating a home — for your stuff, your family, or just yourself. And while it’s true that Americans are more mobile than ever, smart homeowners are hoping to actually own their homes at some point.
To do this, you need to grow your equity, reduce your debt, and — eventually — no longer make mortgage payments. Because houses take so much longer to pay off, it’s easy to feel like you’ll gain nothing by the process of refinancing. In addition, it’s important to stay mindful of how refinancing or debt consolidation may impact your equity. If you consolidate debt, you’re giving up equity. If you take longer to pay off your home, you’re slowing the growth of that equity.
The balancing act also includes factoring in the 3-6% in principal that it will cost you to refinance, to really see if you’re better off. That said, if interest rates are low compared to when you last financed and the costs pan out, perhaps it’s time to start shopping around for a new lender.