When interest rates drop, you may be able to lower your monthly mortgage payments by refinancing.
Get Rid of Private Mortgage Insurance
If you initially put down less than 20 percent of the total value of your home, you may be paying private mortgage insurance, or PMI. When an individual can contribute more than 20 percent to the down payment, the lender or bank has more confidence in the borrower’s ability to pay, and the initial payment provides them protection in the event of foreclosure. PMI protects the lender if the individual hasn’t contributed a significant down payment and can’t pay the mortgage down the road.
Some mortgages allow you to stop paying PMI once you’ve reached a certain level of equity in the home. Refinancing can help you eliminate PMI if you haven’t reached that point yet but your loan-to-value ratio is 80 percent or lower. If the value of your home has increased to the point where you could refinance 80 percent of its value or less, you can get rid of PMI. Eliminating PMI can lower your monthly payment.
Extend the Term of Your Loan
If you only have 20 years left on a 30 year loan, you can cut your monthly payments by refinancing. Maybe your monthly cash flow is tight and you could use more money in your pocket or in your savings account now. If you’re willing to pay a larger sum over the life of your loan, you can refinance to extend the term of your loan. This is referred to as re-amortizing your loan. You’ll split what’s left into more payments, therefore reducing the amount of each payment even if interest rates haven’t dropped.
Refinancing comes with costs, however. Make sure the closing costs from the refinance don’t increase the total loan amount so much that it negates the reason you refinanced in the first place. You can also reduce your interest rate when refinancing by paying discount points. Each point has a cash value, and if you pay that amount up front, your interest over the term of the loan may be decreased.
To determine if paying points will help you save money, calculate the total amount of what you’ll be paying back at the initial interest rate. Calculate the total of what you’ll save if you lower the interest rate. If that amount is greater than the amount of the discount points and you plan to stay in the home for the full term of the mortgage, paying discount points will help lower your monthly payments.
Convert to an Adjustable-Rate Mortgage
An adjustable-rate mortgage, or ARM, may have a lower interest rate, but selecting this type of mortgage can be risky. Interest rates are not locked in, so they can increase over time. If you have an ARM, you may be able to afford the monthly payments now, but can you make payments if the interest rate increases in the future?
If interest rates are trending downward and you expect to stay in your home for a short period of time, refinancing in order to convert your fixed-rate mortgage into an ARM may lower your payments and save you money. Your initial interest rate will likely drop as soon as you convert to the ARM. Plan an exit strategy that you can use when interest rates go up again, though. If you plan on moving in a few years anyway, this method of lowering payments may be right for you. As always, ensure that your closing costs don’t exceed the amount you’ll be saving per month.
Convert to a Fixed-Rate Mortgage
If you’ve been paying on an ARM and your interest rates are increasing, you may save money by refinancing in order to obtain a fixed interest rate. If the fixed rate is lower than the rate on your ever-increasing ARM and interest rates are predicted to continue to increase in the foreseeable future, getting into a fixed-rate mortgage as soon as possible can help you avoid seeing further increases in your monthly payments.
Lower Your Interest Rate
If interest rates have simply dropped since you initially took out your mortgage, you might be able to save money on a monthly basis just by refinancing a traditional mortgage to capitalize on the lower interest rates. If your interest rate will drop by at least 1 percent, you may be able to increase your monthly cash flow by refinancing.
A 30-year $100,000 mortgage financed at 5 percent has a monthly payment of $537. Dropping the interest rate to 4 percent will lower the monthly payment to $478. That gives you $708 more a year to put in savings, pay off credit card debt or use toward remodeling your home.
When you refinance a home, you are typically required to pay closing costs. These may include an origination fee that covers application and processing charges. Closing costs can also involve discount points. Discount points may be tax-deductible, so paying points up front can allow you to claim a deduction when filing taxes. Other fees involved in processing the loan can include those required for the lender to pull your credit report, conduct an appraisal on your home and run a title search. If your current mortgage penalizes you for paying it off early, the prepayment penalty may be rolled into the refinancing costs too.
Make sure the refinancing charges don’t exceed your savings for the amount of time you plan to remain in your home. In other words, if the closing costs for your refinance are $2500 and you’re saving $708 a year, you’ll need to stay in your home for at least 3 and a half years to make the refinance worth it.
Keep in mind that when you’re refinancing a home, you’re starting from scratch. If you’re extending the term of your loan, even though you might be lowering your interest rate and monthly payments, you may be paying more over the course of the loan. That may be fine for your financial needs, but ensure that you understand all of the factors that go into refinancing your property.