Lower Fees, Bigger Benefits: Refinancing Your Mortgage

Refinancing your mortgage can be a great way to reduce monthly payments and reshape your financial future. However, it's not free, and there are costs to consider. The process involves replacing your current loan with a new one, often with better terms. One of the most significant benefits of refinancing is the ability to lock in a lower interest rate, which can lead to substantial savings over the life of the loan. Other benefits include the ability to extend the loan term, switch from an adjustable to a fixed-rate, and even access extra cash by tapping into home equity. When considering refinancing, it's essential to compare rates, negotiate closing costs, and determine your break-even point to ensure the savings outweigh the upfront costs.

Lower interest rates

For example, a $100,000, 30-year fixed-rate mortgage with an interest rate of 7% equates to a monthly payment of $665. The same loan at a rate of 5% reduces the monthly payment to $536. Over the course of the loan, the higher interest rate would result in a total repayment of $422,648, with $262,648 of that being interest.

Even a small reduction in the interest rate can make a significant difference. For instance, dropping your rate by 0.5%—from 7% to 6.5%%—could save you about $133 per month on a $400,000 mortgage loan.

The interest rate you can secure will depend on your credit score, so it is worth trying to improve your credit score before refinancing by paying down debt or correcting errors on your credit report. A higher credit score can lead to a lower interest rate.

You can also reduce your interest rate by paying mortgage points, which involve paying interest upfront in exchange for a lower rate.

Reduced monthly payments

Lowering fees can be a significant benefit when refinancing your mortgage, as it can reduce your monthly payments and free up cash for other purposes. Here are some ways that refinancing your mortgage can lead to reduced monthly payments:

Lower Interest Rates

Reducing the interest rate on your mortgage is one of the most common reasons for refinancing. If interest rates have dropped since you first took out your mortgage, refinancing can help you secure a lower rate, reducing your monthly payments. For example, consider a $100,000, 30-year fixed-rate mortgage. If you refinance and reduce the interest rate from 7% to 5%, your monthly payment decreases from $665 to $536. Over the full term of the loan, that's a savings of more than $40,000.

Extended Loan Term

Extending the term of your loan can also lower your monthly payments, providing some financial relief. However, it's important to note that while extending the loan term reduces monthly payments, it may increase the total interest paid over the life of the loan.

Switch from Adjustable to Fixed Rate

Switching from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage can provide stability and potentially lower payments. With an ARM, the interest rate can rise or fall periodically based on market conditions, potentially leading to higher monthly payments. By switching to a fixed-rate mortgage, you lock in a consistent interest rate, which can be beneficial if you're seeking long-term stability and predictability in your payments.

Eliminate Mortgage Insurance

Refinancing can also help eliminate mortgage insurance, also known as private mortgage insurance (PMI). PMI is typically required when the down payment on a conventional mortgage is less than 20% of the home's appraised value or sales price. However, if you've built up at least 20% equity at the time of refinancing, you may no longer need to pay PMI, reducing your overall monthly payments.

Boosting Your Credit Score

Improving your credit score before refinancing can also lead to reduced monthly payments. A higher credit score can qualify you for better interest rates, resulting in substantial savings over the life of the loan. It's worth taking the time to build your credit score and address any issues or errors on your credit report before applying for refinancing.

Shorter loan terms

Refinancing to a shorter-term mortgage can be a smart financial move if you want to lower your interest payments and own your home sooner. However, it's important to consider the trade-off between higher monthly payments and long-term savings.

When you refinance to a shorter-term loan, you typically qualify for a lower interest rate, which can result in significant savings over the life of the loan. For example, switching from a 30-year mortgage to a 15-year mortgage can lead to a substantial reduction in total interest costs. In one scenario, refinancing to a 15-year loan increased the monthly payment by about $621 but lowered the total interest costs by more than $143,663 compared to the original 30-year mortgage. Additionally, shorter-term mortgages often have lower interest rates than their longer-term counterparts.

However, refinancing to a shorter-term loan will likely result in higher monthly payments. This increase in monthly payments can put a strain on your household budget, especially if you have a young family or are already financially stretched. Therefore, it's crucial to ensure that larger payments fit within your budget and that you can comfortably make these payments each month.

Before deciding to refinance to a shorter-term mortgage, it's essential to calculate your break-even point. This is the point at which your total upfront costs of refinancing are equal to or lower than your total projected savings over the life of the new loan. If you plan to sell or refinance again before reaching the break-even point, refinancing may not be the best option.

There are alternative strategies to consider if you want to pay off your mortgage sooner. You can make bi-weekly mortgage payments, which is the equivalent of making an extra monthly payment each year. Another option is to take your current monthly payment, divide it by 12, and then add that amount to your monthly payment. These strategies can help you pay off your mortgage faster without committing to a shorter-term loan.

Cancelling out premiums

Refinancing your mortgage can be a smart financial move, offering several potential benefits. One of these is the ability to cancel out premiums being paid by the homeowner.

For example, if a buyer cannot put down a 20% deposit on a home, they will be required to pay private mortgage insurance (PMI). PMI premiums can range from 0.2% to over 1% of the total loan amount annually. However, refinancing can eliminate these costs if the homeowner has built up at least 20% equity at the time of refinancing. Equity is the difference between the value of your home and the balance of your mortgage.

It is important to note that refinancing does not eliminate all premiums. For instance, if you refinance from a conventional mortgage to an adjustable-rate mortgage (ARM), you may benefit from a lower initial interest rate. However, the rate on an ARM loan is adjusted periodically, and you may end up paying more in interest over time. Therefore, it is crucial to consider your financial goals and how long you plan to keep your mortgage before deciding to refinance.

Additionally, refinancing can help lower your monthly payments by reducing your loan's interest rate. If you can secure a lower interest rate, you will pay less interest over the life of the loan, resulting in substantial savings. However, it is worth mentioning that refinancing is not always the best option, as it can involve significant closing costs and fees. Before making any decisions, it is advisable to consult a mortgage advisor or financial expert to ensure that the benefits of refinancing outweigh the costs.

Lower upfront costs

Firstly, you can negotiate with your lender to waive or lower certain fees, such as application or credit check fees, especially if you are an existing customer. You may also be able to forgo a new home appraisal or property survey if you've recently had one done. Additionally, using the same title company or attorney for the refinancing as for your original loan may result in repeat customer discounts.

Another strategy to lower upfront costs is to improve your credit score before refinancing. A higher credit score can lead to a lower interest rate, resulting in substantial savings over the life of the loan. You can boost your credit score by paying down debt or correcting errors on your credit report.

It is also important to compare quotes from multiple lenders to find the most competitive rates and fees. A mortgage broker can help you get a wider range of quotes, and your existing lender may offer lower-cost refinance options for repeat customers.

Finally, consider the timing of your refinance. By refinancing during a period of low-interest rates, you may be able to secure a lower rate and reduce your upfront and long-term costs.

Frequently asked questions