You’ve probably heard chatter that interest rates being at historic lows right now. So if you were to buy a home in the very near future, and you have the good fortune of locking into one of these record-low interest rates, hurrah! There’s a chance that you’ll have the absolute best rate terms you’ll ever get.
But let’s say interest rates go down even further in the future. Or, your credit score shoots up into the next tier, and you could qualify for a better interest rate on your mortgage. No need to experience FOMO; in these scenarios, you could consider refinancing to take advantage of these better rates.
Simply put, when you refinance you get a new mortgage that pays off your existing mortgage, explains Holden Lewis, a home and mortgage expert with NerdWallet. People refinance for a variety of reasons, but one common scenario is to lower their interest rates and thus their monthly mortgage payments.
But, refinancing isn’t free. You still have to close on the loan, and closing costs typically range between 2 to 5 percent of the amount you’re refinancing. As an example, if you’re refinancing a $200,000 loan, you’d expect your closing costs to be in the ballpark of $4,000 to $10,000.
“When refinancing, it’s important to figure out at what point in the future you will break even on your refinancing cost,” says Steve Sexton, financial consultant and CEO of Sexton Advisory Group. It might not make sense to refinance if you have a long break-even period, especially if you plan to sell your home before you reach it.
Several refinancing calculators online (here’s one from NerdWallet) can help you determine how much you’d save by refinancing. You plug in figures like your loan balance, original loan terms and interest rate and then the refinance terms and rate, and the calculator will give you an idea of what you could save. Once you get serious about refinancing, a financial adviser can help you determine if it’s the right move.
Another common reason for refinancing is to shed the mortgage insurance you’re paying if you took out an FHA loan and put less than 10 percent down, Lewis explains. FHA loans are popular with first-time buyers because of the low down payment requirements. In 2019, first-time buyers made up 83 percent of FHA home loan borrowers, according to the Federal Housing Authority.
With conventional mortgages, your private mortgage insurance—the monthly payment you make that protects your lender should you default on your home loan—drops off once you build enough equity in your home. However, to get rid of mortgage insurance on most FHA loans, you actually have to refinance into a conventional loan.
The takeaway here? Even after you close on a mortgage, it’s a good idea to keep tabs on interest rates so that you can decide whether refinancing makes sense for you.
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