When's the right time to refinance?

Refinancing your home can save you on your monthly mortgage payments — if done correctly. But if you don’t refinance when conditions are right, it can also cost you a pretty penny. Here’s how to figure out if refinancing is right for you.

The Rate Isn’t Everything

When it comes to mortgages, the rule of thumb is that refinancing only really starts to make economic sense when you can get at least a 1 percentage point decrease in the interest rate. However, falling rates shouldn’t be the only factor in your decision to refinance. Sure, a greatly improved interest rate can save you money, but to figure out if you will come out ahead, you’ll also have to factor in the cost of closing on a new loan as well. Closing costs can often add thousands of dollars to the cost of a loan, so you’ll need to do the math to figure out when or if you’ll break even. Some lenders advertise loans without closings costs, but you should be wary of those offers. Often the lender just ends up adding the closing costs back in through inflated monthly payments or a slightly higher interest rate.

A Better Rate With Worse Terms

A rate that saves you money is great, but might not be worth it if it comes with more restrictive terms. To squeeze more money out of homeowners, lenders are adding in punitive terms and hidden fees. For instance, many lenders are now adding prepayment penalties to mortgages, which would prevent you from refinancing your loan for several years, something that you’d want to avoid if you think rates might dip even lower in the future. A lender might also insist that you use their preferred home inspector or attorney during the refinancing process, which might cost you more than if you were able to shop around on your own.

Extending the Life of Your Loan

When refinancing, homeowners face a decisions: keep the same timeframe for repayment, or extend the term of the loan. By lengthening the loan, homeowners can substantially lower their monthly payment, freeing up a lot of extra cash. But doing so also means shelling out more to pay down interest. So even with a lower overall interest rate, you might end up paying more over the course of the loan. As a homeowner, you’ll have to figure out your main priority: free up more cash today by lowering your monthly payment, or decrease the total amount you’ll spend on interest over the life of the loan.

Changes in Your Credit

Interest rates may have fallen in the years since you bought your home, but your credit situation has likely changed as well, and not necessarily for the better. If you’ve loaded up on credit over the years, perhaps by buying a car or signing up for additional credit cards, you could have weakened your credit situation, leading lenders to offer you a rate that’s no different, or even worse, than what you currently have.  Life changes can also alter the credit rate you might get. For instance, you may have been working for an employer when you took out the initial loan, but have since transitioned to self-employment. So before you get too far into the refinancing process, do a credit check on yourself and compare it to the credit report you got when you first bought the home.

Know Your Home’s Value

Homeowners often get pretty far along in the refinancing process only to have the deal fall through at the last minute, costing them a great deal of time and money in wasted fees. Usually this occurs when the appraiser comes back with bad news: the home’s value has fallen or stagnated in recent years. Before you get started on the refinancing process, get a good idea of what your home is worth. Hire an appraiser, or do some research in the local housing market to avoid a costly surprise down the road.