When you first buy a house, you shop for the best financing available. A few years later, if mortgage interest rates drop, especially by more than one percent, should you think about refinancing your home loan? People who bought a home in the early 1980s at 15% were rushing to their mortgage lender in the 1990s when rates dropped to less than half of that. Homeowners can save considerable money by taking advantage of falling interest rates. Monthly mortgage payments can be lower giving you more cash flow. Refinancing can also shorten the time it takes to pay off your mortgage.
Experts agree that, in general, you should consider refinancing your home when there is a drop in interest rates of 2 percentage points or more. You can calculate what your savings would be using any one of a number of mortgage calculators. But there are a lot of other things to consider.
First is the equity in your home. You may lose equity when you refinance, and will take a longer time before your mortgage is paid off if you are refinancing at a longer term than when you originally buy a house.
There are considerable costs involved in the actual refinancing, which may make it less desirable to look at a new mortgage. Refinancing involves actually paying off your original mortgage and then taking out another mortgage to replace it. Before refinancing, you will have to pay for a property appraisal, title insurance, escrow fees, and other filing expenses. Unless you plan to stay in the home until these costs are covered by the savings you see, then you may not be getting such a good deal. Banks that offer “no-cost mortgages” may not charge you fees during closing when you buy a house or refinance, but there are still fees involved – usually added to the loan balance where they will be compounded with interest.
Remember that interest rates make up a large part of your mortgage payments during the first few years of your loan. Refinancing can also save you money by eliminating Private Mortgage Insurance (PMI) that is required for most new mortgage loans, especially when you buy a house for the first time. Once the equity in your home reaches 20%, most lenders will let you drop your PMI. If your loan is with a lender who does not remove your PMI payment when you reach this level of equity, it might be very cost effective to find one that will.