What You Need to Know About Refinancing

Posted by Lindsay Gough on Friday, January 23rd, 2015 at 7:30am.

A recent article in the New York Times argued it was time to refinance your mortgage since interest haven fallen to their lowest point in years.

“The average rate on a 30-year fixed-rate mortgage was 3.8 percent at the end of last week. That is down from 4.5 percent as recently as last spring, the lowest since May 2013 and far below the 5 percent-plus rates that prevailed as recently as early 2011.”

Is it a good time to refinance your mortgage? Is that always a good decision? Here are some things you need to know about refinancing your mortgage.

How Does Refinancing Work?

Refinancing your mortgage mean you effectively pay down your current mortgage and take out a new one with a new interest rate. As the New York Times article points out, this can get you a lower interest rate. Sometimes banks write a whole new loan, and other times they change the terms of your current loan.

Why Refinance Your Mortgage?

There are two main reasons people refinance a loan. First, a lower interest rate could mean a lower monthly payment. You could save money every month. The other option is that you receive a lower interest rate and pay the same monthly payment, which will help you pay off your loan sooner.

When you refinance, your home is appraised again. If the amount for your new loan is greater than your old mortgage, than you will receive the extra amount in cash. This can be used to pay down other debts or going into savings or investments.

When Should You Not Refinance?

While refinancing is typically financially sound when done right, it can more financial problems if done for the wrong reasons. Refinancing costs money in fees and closing costs. Investopedia estimates it costs about 3-6% of the loan’s principal to refinance. It will take a few years to pay off those closing costs and fees, so it doesn't make sense to refinance if you plan on moving anytime soon. Otherwise, it may end up costing you more in the long run.

Also, you don’t want to extend your loan term. Refinancing is a great way to pay down your loan faster and consolidate debt. However, it is possible to get a new loan with a longer loan term then your current one. This is counterproductive. You want to refinance to get out of debt sooner, not be in debt for longer.

While the current interest rates could make this a great time to refinance, look closely at your personal finances to see if it is a good time for you. You only want to refinance once, so talk to your bank to see if refinancing can save you money in the long run.

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