This week, interest rates on mortgages dropped yet again, leaving many homeowners wondering if now is the time to refinance. The average 30-year fixed-rate mortgage is at 4.1 percent, and a 15-year fixed-rate mortgage is even lower, at 3.35 percent. If these sound good to you, now may be the time to lock in a great rate. However, let’s consider several factors that will help you make a wise decision.
Refinancing a mortgage isn’t free. In most cases, the costs will be similar to those you paid when you got your original mortgage. You’ll pay a loan origination fee of usually 1 percent of your mortgage balance, plus a miscellaneous collection of appraisal, survey, inspection, and title fees that usually add up to well over $1,000. You can either pay this out of pocket or add it to your balance in one of two ways. The first is to directly increase the amount you borrow, like with a small cash-out refinance, and the second is to get a slightly higher interest rate and use the rebate from the lender to pay the fees. Either way, you’ll pay for it later, so the best choice is to pay the fees out of pocket when you refinance.
The main thing to calculate before deciding whether to refinance is how much money you will save in interest over the remaining life of the mortgage. Compare the remaining interest you’re scheduled to pay on your current mortgage to the interest you will pay on the new mortgage. A mortgage calculator can help you with this. Or another trick, if you know the monthly payment, is to multiply the monthly payment by the number of months remaining in the loan and subtract the current principal to get the total remaining interest.
Although many people focus on the monthly payment, don’t fall into the trap of doing this exclusively. This is because there are two ways to reduce your monthly payment: getting a lower interest rate and choosing a longer repayment term. The former will truly save you money, whereas the latter can actually cost you more! Therefore, although you should make sure you can afford the monthly payment, don’t focus on it. In fact, the best strategy may be to switch down to a 15-year mortgage so you can finish paying it off sooner.
Part of how you can get the best interest rate possible is by having a great credit score. Although developing a good score generally takes years of practicing good habits, there are some things you can do in the months leading up to applying to refinance your mortgage. First, don’t apply for any other new credit. Second, pull your credit reports through AnnualCreditReport.com, look over them for errors, and file disputes if you find errors. Third, pay down your credit card balances. Ideally, you should have a credit card balance of no more than 30 percent on each card, although lower is even better.
If you’re ready to go ahead with a refinance, it’s time to contact your current lender and at least two others to get interest rate quotes. Once you pick a lender, lock in your rate and get the ball rolling on your refinance!