When should you refinance your mortgage?

As mortgage interest rates start to rise, many homeowners are wondering - should I refinance right now? 

There are many situations when refinancing can save you thousands of dollars and shave off your repayment timeline. But there are also times when refinancing isn't the best solution. 

Before you make any major decisions, you should first consider how a refi can help you. If you have a strong credit history, you may qualify for lower interest rates. See what rates are currently available by filling out this simple survey. 

Still not sure if now is the right time? Read below for a more thorough breakdown of the process and when you should - and should not - refinance your home loan.

When you should refinance your mortgage 

There are some obvious reasons to refinance, essentially replacing your existing home loan with a new one. Perhaps you want a new loan term, are looking to lower your monthly payments, or want to take advantage of favorable mortgage refinance rates. 

As you weigh the pros and cons, you may want to first find out what mortgage interest rate you could qualify for. Fill out what type of loan you're looking for and follow the prompts to determine your potential savings.

If you've been a homeowner for a while, then you may not be in the same financial position as you were when you first took out the mortgage. Here are three scenarios in which it's a good idea to refinance your mortgage.

You can remove PMI

Private mortgage insurance (PMI) is a fee you have to pay on a conventional mortgage if you have less than 20% equity in the home. When you make a down payment that is less than 20% of the purchase price, the lender will add PMI to the monthly payment.

PMI generally costs anywhere between 0.2% and 2% of the loan amount annually. If your home's value has appreciated significantly, you may be able to remove PMI by refinancing, which can save you hundreds or even thousands of dollars each year.

You need to remove a cosigner

When someone cosigns a loan, the loan will appear on their credit report and could impact their own ability to qualify for a loan.   

If your cosigner asks you to remove them from the loan, you can do so by refinancing into a new mortgage. Depending on how market rates have changed, you may not be able to qualify for the same low rate you had when you first took out the loan. 

You've become a more desirable candidate

When you apply for a mortgage, a lender will use your credit score and income to decide what interest rate you qualify for. If your credit score, income or both have improved since you first applied, you may be able to get a much lower interest rate.

For example, if you had a 650 credit score when you first applied and now have a 750 credit score, you may receive a better interest rate offer. 

Do you know your current credit score? If not, don't worry. There are online tools you can use to find out your credit score. 

When you shouldn't refinance your mortgage

There are also plenty of reasons to hold off on refinancing your mortgage. Everyone's situation is different. So, before you start filling out any paperwork, make sure you take a look at some top reasons to possibly postpone your refinance.

You plan to move soon

When you refinance a mortgage, you have to pay closing costs, just like you did when you initially took out the loan. Closing costs range from 3% to 6% of the loan amount. For example, a $200,000 mortgage could have closing costs between $6,000 and $12,000. 

In most cases, it can take about five years after refinancing to break even on closing costs. If you plan to move before that time frame, then you should avoid refinancing. 

You'll end up paying more in total costs

When deciding whether or not to refinance, most people start by comparing their current interest rate and overall market rates. But you should also consider what you'll pay in total over the life of the loan.

For example, let's say you took out a $200,000 30-year mortgage with a 5.5% interest rate. You took out this loan 10 years ago and now qualify for a 30-year term with a 4.5% interest rate. If you refinance, your monthly payment will be $288 less. 

However, by restarting the loan term, you'll actually end up paying $30,870 more in total interest because you've effectively lengthened the loan term by 10 years. 

Should you take out a cash-out refinance?

A cash-out refinance is when you refinance your mortgage and remove most of the excess equity. You can receive the extra equity as cash, which you can use to pay for a child's college education, complete home repairs or to eliminate high-interest debt.

A cash-out refinance has the same closing costs as a traditional refinance, so you should be careful before you apply. If you use a cash-out refinance for a vacation, a wedding or luxury goods, those items could end up costing you hundreds or thousands in total interest over the long run.

It's best to only use a cash-out refinance if you're using the funds to add to the home's value, pay off debt with a much higher interest rate or invest in another property. Otherwise, you should leave the equity in the home.

What about a reverse mortgage?

If you need extra cash but don't feel like you would benefit from a mortgage refinance, you can also look into a reverse mortgage. 

A reverse mortgage allows homeowners (62 and older) who have paid all or most of their existing mortgage, to withdraw a portion of their home's equity. This is considered tax-free income. It needs to be repaid, however, if the homeowner dies or elects to sell the home. The advantages of this alternative are multiple:

• It can help eliminate the existing mortgage payment (by using the equity to pay down the balance).
• It can provide a reliable source of cash.
• The money can be disbursed in a variety of ways (credit line, monthly payments, etc.).
• The balance of the loan won't exceed your home's value, so there's no need to worry about putting yourself into debt.

This option is only available to older Americans but those who qualify may find it more advantageous than the traditional mortgage refinance. If this is something you would like to explore further, reach out to an expert who can answer any questions you may have.