A cool thing about owning your home is in time it affords you the chance to get a better deal on other things—including the loan you originally used to purchase the home. Refinancing is a great way to use the stake you have in your property to save yourself money in the long run. Choosing the right timing when you refinance is important for getting the best deal out of the process. The sweet spot for refinancing will depend on your existing loan type and what you look to gain through your refi. Refinancing too early can result in additional fees and fines, whereas waiting too long can leave a bundle of money on the table, paid out to interest and not benefiting your investment. Here are some common refinancing scenarios and a little advice on how to approach your refi timing:
Improving interest rates. Quite often people take the loan they can get in a rush to move into their home. Interest rates are constantly fluctuating, and at times when rates are particularly low it can seem like you got a bad deal on your loan. Refinancing helps you take advantage of current market conditions and use the equity you’ve built up to secure a better loan rate. Most lenders require borrowers to pay the original loan rate for at least 12 months before they can refinance. Closing on a refi means paying for an appraisal, title search, and other closing costs all over again too, and in many cases that’s a waste of money when you’ve just recently secured a loan.
When is the time right? You can start thinking about it after as little as 120 days, but consider how long you will be in your home for. If you’re planning on selling within seven years, you may not make back what you pay out in closing costs with your savings. Unless your interest rate is completely out of line with current rates, waiting 2-5 years is a good gauge.
Shorter mortgage term. Adding a little to your monthly payment can result in big savings over time. As a rule, 15 and 20 year loans have lower interest rates than 30 year loans. Paying one or two percent less to the bank every month in interest can add up to thousands of dollars over the course of the loan. In one example given by Bankrate, reducing the term from 30 years to 20 years one third of the way through the loan term resulted in a 1 percent interest rate decrease—and saved the borrower more than 38 thousand bucks on a $186,000 home.
When is the time right? If you plan on staying in your home through most—or all—of the loan term before moving, refinance to a shorter loan when you can afford the payment increase comfortably.
Avoiding balloon payments. There are a lot of adjustable rate mortgages out there. Some of them start you at a low rate for a period of time, with payments only covering interest or even not covering all of the interest paid out. Once that period ends, your payments will increase substantially in what is commonly called a balloon payment. Other loans, such as 7/1 loans, will adjust with the current benchmark interest rate and can go up several percentage points depending on the market (then be locked in for a period of five years or more). If you are approaching the end of your grace period, refinancing into a fixed rate loan (or a more stable ARM) when interest rates are low and you have equity to use to your advantage can prevent a substantial payment increase.
When is the time right? Depends on the type of ARM you have. You will want to be prepared and start looking for a refi at least a month or more before your payments go up, as a missed payment after the increase can lower your credit score (and subsequently make it more difficult to get an adequate rate on your refi later on). Examine your terms and conditions and have a game plan. Consult with a mortgage broker if you’re not sure.
Mortgage insurance. Loans with looser credit and down payment standards like those underwritten by the FHA will often require mortgage insurance be paid monthly—often to the tune of $100 to $500 on top of your payment. Mortgage insurance is costly and in time you have enough equity in the home where it’s no longer necessary. Refinancing out of your FHA or PMI-required loan can save you hundreds or thousands of dollars per year.
When is the time right? As soon as you have paid enough into your home that you can refinance into a new loan. Usually, you can refinance into a conventional loan when you’ve got around 20 percent equity in your property.