Your Neighbor Refinanced – Should You?

Before we talk about scenarios when it makes sense to refinance, let’s briefly define what exactly a mortgage refinance is. Basically, refinancing takes place when you pay off your current mortgage with a new one.

At first this might seem pointless. After all, a mortgage is a mortgage, right? Wrong. The whole point of refinancing a mortgage is to take advantage of a better interest rate.

For example, if you have improved your credit score since your first mortgage loan, you would likely qualify for a better interest rate on a new mortgage loan. In such cases, you can pay off your old mortgage with a new one, and enjoy a lower interest rate on the new loan. This of course means you will pay a smaller mortgage each month. That’s the primary goal of mortgage refinancing.

When to Refinance

Now that we understand what it means to refinance a mortgage, let’s talk about scenarios when it makes sense to do so. Just because your neighbor, friend, or family member refinanced doesn’t mean you should. But as a general rule of thumb, it’s probably a good time to refinance if the interest rate is two percentage points below your current rate. In such cases, the money you would save each month would certainly make up for the upfront costs of refinancing your mortgage (origination fees, etc.).

Another scenario might occur if your income has increased. If you are making more money than when you first took out your mortgage (and you can afford a higher mortgage payment), you could refinance the mortgage to shorten the term of your mortgage. If the current interest rate is lower for the shorter-term mortgage, it would make sense to refinance the mortgage. Oppositely, you might wish to make larger principal payments against your mortgage to pay it off sooner. These are all possibilities with a mortgage refinance.

A third (and common) refinancing scenario occurs when home buyers trade their adjustable-rate mortgage (ARM) for a fixed-rate mortgage. At this time, home foreclosures have gone way up. This is largely due to ARMs that are adjusting and catching the homeowners off guard with much higher interest rates. Many people in this scenario have refinanced for a fixed-rate mortgage. This strategy also allows the homeowner to lock in a more favorable rate for the life of the loan. No more surprises!

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