How to Refinance Your Home Before It’s Too Late

Rock-bottom mortgage rates are rapidly receding into the past. Take these seven steps before the window closes.

Whether you’re thinking of refinancing or buying a home, now is the time to get that loan if you possibly can.

Reason: Mortgage interest rates are climbing. This week, the Federal Reserve increased the federal funds rate (the rate banks pay to borrow money from the federal government) and more hikes are expected, driven by signals of a strengthening economy. These incremental increases typically will also bump up mortgage rates over time.

Here are seven steps to follow when shopping for a mortgage.

1. Keep an eye on interest rates

Even small movements in mortgage rates can make a big difference in your monthly housing costs and in the interest you pay over the lifetime of your loan.

Look at it this way: If you’re borrowing $300,000, just a half percent difference in the interest rate costs you roughly $89 more per month. (You can play with the numbers on a mortgage calculator like this one.) And should mortgage rates rise a full percent, from an average rate of 4.45 percent on a 30-year fixed interest loan (per Freddie Mac on March 22) to 5.45 percent, the monthly cost of that loan rises by about $181 per month, or $65,160 over the 30-year life of the loan. Not chump change.

Here are the monthly payments:

  • at 4.3 percent: $1,568
  • at 4.8 percent: $1,657
  • at 5.3 percent: $1,749

Use Money Talks News’ mortgage rates page to keep an eye on rates where you live.

2. Figure out if refinancing pays

Will you come out ahead if you refinance? The devil is in the details.

Refinancing to a lower rate lowers a monthly mortgage payment. But it’s only worth it if the month-to-month savings exceed the cost of refinancing. In short, don’t do it unless you’ll stay in the home until you’ve saved more from the lower rate than you paid in refinancing fees.

Your break-even point is easy to compute: Divide your total refinance costs by your monthly savings. The result will be the number of months it will take to break even. Example:

  • Total cost to refinance: $2,000 (This includes all expenses and fees, from the initial appraisal to the final closing costs.)
  • Monthly savings from lower rate: $100
  • Months to break-even: 20

In this example, if we plan to stay in the house for more than 20 months, the refinance will pay for itself. If not, we’ve endured the hassle of refinancing and lost money in the bargain.

Use an online calculator like this one to compute your break-even point.

3. Can you lower your monthly payment?

A lower monthly mortgage payment is always welcome. Refinancing to a lower interest rate should drop your payment. But you can’t be sure, since the details depend on your loan amount, your credit score and other factors. (Bone up on mortgage basics by reading “Home Buying 101: How to Choose the Best Mortgage Option for You.”)

4. Get rid of your mortgage insurance

If you bought your home with a down payment smaller than 20 percent of the purchase amount, you probably were required to buy mortgage insurance. (It protects your home’s lender, not you.) Private mortgage insurance (PMI) charged on conventional loans can cost 0.5 percent to 1 percent of your loan’s value. Federal Housing Administration (FHA) mortgages include mortgage insurance, too.

PMI adds $41.50 to $83 a month to your payment for every $100,000 of your mortgage. With FHA mortgages and some conventional loans, you have to pay mortgage insurance for the life of the loan — refinancing is the only way out.

However, if you have 20 percent equity in your home when you refinance — whether through your payments or from appreciation of your home’s value — you won’t need mortgage insurance. (For more information on how and when you can stop paying PMI, click here.)

Check with your lender to see if your principal payments have exceeded 20 percent of the loan value. To figure your equity in an appreciating housing market, estimate the current value of your home. Here’s how to figure your home’s value:

  • Research just-sold listings online for properties near yours and like yours. Two sources: Realtor.com’s Just Sold section and the “Recent Home Sales” under the “Buy” tab on Zillow.
  • You can also look up your county tax assessor’s valuation of your home, although it may not accurately reflect the market value.
  • You can also look at estimates of your home’s value on real-estate websites — Zillow’s Zestimates, for example — to get a rough idea of value.

5. Decide if you want to extract cash

Home values have been rising, and nationwide have nearly reached the peak hit in 2006 amid the housing bubble. That means you may have more home equity. One way to tap it without selling your home is to refinance and take out cash. (You could, instead, get a home-equity loan, a line of credit or, depending on your circumstances, a reverse mortgage.)

6. Pay down your home faster

Rates still are low enough that, depending on the interest rate you qualify for and your current monthly payment, refinancing into a 10-, 15- or 20-year mortgage might increase your payment only a little yet save tens of thousands of dollars in the long run and allow you to own your home free and clear sooner. For help clearing that debt, read “7 Painless Ways to Pay Off Your Mortgage Years Earlier.”

7. Lower your rate with a short-term adjustable mortgage

Thirty-year fixed-rate mortgages are the safer and more-traditional choice, but an adjustable mortgage (ARM) may meet your needs under certain circumstances, for example if you will sell the home before the loan’s introductory low-interest-rate period ends.

ARMs are attractive because their initial interest rates, typically, are lower. But they are riskier: After a fixed-rate period, the interest rate can change regularly. The 5/1 ARM, for example, has a fixed rate for five years and then the interest rate can fluctuate each year after that. Some ARMs adjust more often — twice a year or even every month. If the rate goes up, as is likely these days, your mortgage could suddenly become a lot more expensive.

Many homeowners used adjustable mortgages to buy homes cheaply during the housing boom, expecting to sell or refinance after the fixed rate period ended. Instead, they were stranded — and in many cases ruined — by the crash in home values. With homes worth less than the mortgage they did not have sufficient equity to allow them to sell or refinance. Often, foreclosure followed.

In “Home Buying 101: How to Choose the Best Mortgage Option for You,” you can find the pros and cons of adjustable mortgages. If you are considering an adjustable mortgage:

  • Read the contract very carefully and make sure you understand every bit of it.
  • Get a lawyer or trusted friend or family member to review the fine print with you. Do not rely exclusively on the loan salesperson for understanding your obligations.
  • Be sure you would be comfortable making the highest-possible monthly payment under your contract. Find the maximum interest rate you could pay. Figure out what that would do to your monthly payment.
  • Carefully assess the demand for homes in your housing market. You want to know that you’ll be able to sell the home when you want to leave.

Have you refinanced your home or otherwise borrowed for a mortgage? Tell us about your experience at our Facebook page.

Marilyn Lewis
Marilyn Lewis
After a career in daily newspapers I moved to the world of online news in 2001. I specialize in writing about personal finance, real estate and retirement. I love how the Internet ... More

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