How to Refinance Your Mortgage
January 25, 2019 | By Daniel Dewitt
There's a lot of reasons you may want to refinance your mortgage, but the primary one is simple yet powerful: you don't want to pay as much month to month.
If you're a homeowner, a mortgage payment is no doubt the number one recurring expense that most drains your bank account each month, and lightening that load even a fraction could drastically shift your financial situation for the better.
How do you go about it, though? What does the process look like? Where do you start? Those are all questions we're here to answer today as we guide you through how to refinance your mortgage.
Refinancing: Pay Less for Longer
When we talk about refinancing there are two paths you can take. The most common, which we mentioned above, is to lengthen the term of your loan so you pay less each month.
So, for example, if you originally agreed to pay $1,000 a month for 30 years (don't salivate, this is just a hypothetical example) and 10 years in you decide to refinance. The bank agrees and however much you have left to pay off on your home (let's say $20,000) is then spread out over another 30 years, reducing your monthly payment to $660.
Great, right? Well, not exactly. See, we left out interest in the above example.
Interest is the money you pay the bank to let you borrow in the first place, and the tricky thing about it is that when your refinance in the above example the amount of interest you pay each month doesnÕt change, which means over the life of the loan (40 years now instead of 30) you'll end up paying more to the bank in total. Essentially, if you view the loan as a single product, it becomes more expensive.
This is the tradeoff that comes from refinancing this way: you have the utility of having paying less month to month, but you also end up paying more in total.
For many people it's worth more to pay less month to month: if youÕre having trouble with bills it can mean keeping the lights on, if you canÕt make your car payments it means keeping your car, and it potentially means you can invest in other things (retirement, businesses, stocks) which will accrue interest at a higher rate than you'll lose it by paying more on your mortgage in total.
Refinancing: Pay More for Less Time
On the opposite side of the coin, it's possible to refinance to shorten the length of your loan by paying more each month. Doing so you'll pay less interest over the life of the loan which means less total.
While this may seem crazy to some people, there are actually some really smart reasons you should do this depending on your situation. Often you don't have access to any kind of long term investment that will accrue you money at a higher rate than it will be drained by the interest rate on your mortgage.
If you're middle class or lower the truth is that there are few investment options open to us that have higher than the 5% interest rate that's average for most mortgages, and so ensuring you pay less in the future is its own kind of investment.
Also, some people just like to own their home outright without any third party bank involved. This doesn't really have much financial utility unless some kind of housing crisis hits, but is nonetheless a valid reason to refinance.
Calculate Your Refinance
If all this sounds complicated, then we suggest starting out with a mortgage refinance calculator. A refinance calculator is a handy tool for getting your head more or less around the numbers you'll be working with.
It won't let you know the exact interest rates or terms of the deal you'll be offered by a given lender, but it will make it easier for you to grasp the possibilities and impact of the loan when you do receive an offer from a lender.
Another important step before you start trying to refinance is to look up your credit score. This is relatively easy to do (you're legally obliged one free report a year, and it can be done online), and will give you an idea of what kind of interest rate you can expect. As a rule of thumb, the higher your credit score the lower you can expect your future interest rate.
A Note of Caution
One thing you need to consider before pulling the trigger on refinancing your mortgage is to determine how much your house is actually worth currently. Refinancing is only beneficial if your house has increased in worth (which most do over time simply because of how the real estate market works), but if it hasn't, then refinancing will actually end up costing you more both in the short and long term.
How do you know if your house has decreased in value without actually tipping your hand by having the bank inspect it? The easiest way is to just do a little online research. You'll want to search for what homes in your neighborhood and area are selling for. Another option is to have a third party inspect your home and give you an estimate, but that can be pricey and so often isn't everyone's first option.
Prep for Success
Refinancing your mortgage can be tricky, but doesnÕt need to be complicated. If you follow our steps, you should be able to do so successfully and with a minimum of headache. Just remember to first decide whether you want to pay less each month or less total in total, then do what you can to calculate what your refinanced mortgage will look like, and finally to consider whether your house has decreased in value. Weighing those three factors will make sure you make the right decision.