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When you buy your home, it may not always be under the perfect circumstances. Your credit may not have been good enough to qualify you for the best interest rates. You may not have had the down payment you wanted. You may taken on more than you could really afford in your enthusiasm to own your first home.
Refinancing can be the answer for many homeowners trying to balance their budget and meet their financial goals. In some cases, it can save you hundreds of dollars a month. However, it is not always the most appropriate solution. It's important to understand the pros and cons to ensure that you make the right decision for your personal circumstances.
One of the best signs that it's a good time is that interest rates have dropped or that you now qualify for lower interest rates based on your improved credit score or credit history. A two-point interest rate deduction on a $100,000 home alone could save you tens of thousands of Dollars over the life of a 30-year, fixed-rate loan. Typically, a full point or two is necessary to make refinancing worth your while. The savings from a half-point or less may take years to offset expenses, depending on the terms of your loan.
Another good reason to refi is if you want to get out of an adjustable-rate mortgage or to eliminate a second mortgage loan, or a piggyback loan. When your ARM is going to reset to a higher interest rate, you may be able to shift into a fixed-rate loan with a lower interest rate. Of course, your credit history will need to have improved significantly from when you were approved for the original loan. You can also refi to consolidate two loans into one single loan with one monthly payment.
A less-popular option is the “cash out” refinance, which can be used to help pay down other higher interest debts. The cash out option involves taking out a loan for more than the original loan amount — assuming you have built up some home equity — and taking out the difference from the amount you still owe on your mortgage in cash. You can use that money to pay down debts, though you might have to pay a higher interest rate.
An often overlooked reason to refi is to pay off your home more quickly, perhaps in preparation for retirement. Instead of paying off your mortgage for another 25 years, you can pay it off in 15. Though you may have to pay more per month, you may end up spending far less over the years as a result of a lower interest rate.
Refinancing won't always save you money. It typically involves the same closing costs as your original loan, including attorney fees, appraisals and title insurance — though some fees may be waved as banks compete for your business. To determine if it is the best choice, you should compare your monthly savings to the costs you will have to put in and find out how long it will take you to break even. If you don't plan to live in your house that long — and preferably longer, refinancing isn't worth it. You may also face additional costs if your original loan has an early prepayment penalty.
The above calculator can help you quickly break down your costs and benefits to better understand if refinancing is the right choice for you. The calculator takes into account your interest rate, length of the loan, the amount of time you plan to stay in your home, origination and closing costs and taxes so you can get a complete financial analysis.