ASK A FINANCIAL PLANNER: 'Should I refinance my home?'
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Certified financial planner Sophia Bera answers:
I bought my house about a year and a half ago, and since then interest rates have declined by about half a percent.
If I refinance now, I would save about $200 per month on my mortgage, but I know there are some costs that are associated with closing on the new mortgage.
Plus, getting a new 30-year, fixed-rate mortgage after paying off about a year and a half of my current mortgage would mean an additional year and a half of payments, which leads to more interest payments that I would have to make over the life of the new mortgage.
What should I take into consideration when deciding whether to refinance?
Congrats on your home purchase! There are many things to consider when you are refinancing:
- How much longer are you planning on living in the home?
- How much are the closing costs?
- What is the difference in the interest rates?
- How long before you would break even?
If you plan on selling the home in a few years, it's probably not worth it to refinance. For example, if the closing costs to refinance would be $3,000 and you'll save $200 a month on the mortgage, then it would take 15 months in order to break even.
Closing costs can really vary by lender, so be sure to shop around. I highly recommend checking out credit unions as well, because I've found that they have some of the most attractive refi rates available.
I think a good rule of thumb is that if you can lower your interest rate by at least .75% then it's worth it to look into refinancing. It's even better when you can lower your interest rate AND shorten the terms of your mortgage. For example, say you took out a mortgage at 4.5% when you bought your home five years ago and now you can refinance to a 3.75% 15-year loan, thus cutting another 10 years off of the mortgage saving yourself thousands of dollars in interest over the life of the loan.
Flickr / nola.agent
If your credit score has gone up significantly between the time you bought your home and now, you might be able to qualify for a much better interest rate when you refinance, which could be a compelling reason to refinance. Just make sure you have enough equity in your home because you don't want to get stuck paying PMI if you're not paying it right now.
If you're currently paying PMI, another reason to refinance would be if the equity in your home has gone up significantly and you're able to refinance and get rid of your PMI. This would help save you even more on your monthly mortgage. You generally need at least 20% equity in your home to avoid PMI.
If you can refinance for only a few thousand dollars and you're planning on living in your home for at least three more years, I would say that moving forward with the refinance would be a smart idea.
However, now that you're saving $200 a month on your mortgage, make sure you put that $200 to good use. I recommend using that money to pay down debt, build up savings, or add it to your retirement accounts. Don't let that $200 in monthly savings get swept away in lifestyle creep.
Sophia Bera, CFP® is the Founder of Gen Y Planning and has been quoted in The New York Times, Forbes, Business Insider, AOL, The Wall Street Journal, and Money Magazine. She tweets, travels, and loves helping millennials manage their money more effectively. Curious? Sign up for the free Gen Y Planning Newsletter.
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