Now there are some important things to consider whenever you’re going to refinance. So here are my four rules for a home-run refinance.
- First, can you lower your interest rate? A lower interest rate means you’ll spend less money repaying the bank for your loan. All good. Today’s interest rates are near historic lows, and chances are that you can do better than the 11 percent, the 7 percent, or even the 5 percent interest rate you have now and believe me, I hear from people every single week who have each of those. Can you lower your mortgage payments?
- This is point number two. Ideally, you want to pay less each month and you can do this by extending your mortgage term, which is not great because if you took out a 30-year mortgage rate–, mortgage term initially, and now you want to take out another 30-year mortgage term you’re going to end up paying interest on interest. While lowering your monthly payments will give you more breathing room, it’s not usually worth the extra cost you’ll pay over the long term. Now if you tell me that number one on your list is paying less each month and you don’t care how many years you have to pay it then you’re going to go for that even if you do have to do another 30 year term.
- But for most people the kicker for really saving money is point number three: reducing the length of your loan term. So if you can secure a low enough interest rate, you’ll be able to reduce both the length of your loan and the cost of your monthly payments—those savings really will add up.
So for example, if you took out a $250,000 refinance loan at 5 percent for 30 years, you would pay almost $230,000 over the life of the loan in interest. But if you shave five years off that same loan, you’ll save nearly $45,000. Now, imagine if you are shaving 5 years off that loan and now you’re bringing down the interest rate as well, and your savings are going to multiply. The last thing, and the thing that people sometimes forget to do, is you have to manage the costs of the refinance.
So on top of administrative fees, your home must also be appraised, inspected, and assessed and you may pay a penalty for paying off your mortgage early, and that typically– that early prepayment penalty is only in the first 2 to 6 years of the mortgage so check the details of your current mortgage agreement before moving ahead with a refinance. Whatever you do, make sure you can pay off the costs of the refinance within six months to a year, and try to keep the costs under $1,000 to $2,000 all in. It’s going to be a little bit harder to do if you have a higher-end cost home but if your home is only maybe $100- to $200,000, or rather the mortgage amount, somewhere around between $1,000 to $2,000 to $2,500 would be ideal.