When Should You Consider Refinancing?

Here’s another example of the new post-recessionary mindset of the average American: according to mortgage backer Freddie Mac, more homeowners opted for “cash-in” refinancing in the fourth quarter of 2010 than ever before while “cash-out” refinances dropped to an all-time low.*

Of course, refinancing—whether it’s cash-in or cash-out—isn’t for everyone. While interest rates continue to be at record lows, there’s a lot to consider before deciding that it’s the right decision for you right now. Here are a few indicators that could point toward “yes”:

You need to lower your monthly payments. If your financial situation has changed and you need more money for monthly necessities like food or medicine, refinancing to a lower rate or longer term (from a 15-year mortgage to a 30-year, for example) can help relieve some of that strain. Just realize that you may end up paying more in the long run if you’re making payments for a longer period of time.

You want to pay off your loan faster. Although you could still do this by making a few extra payments each year or paying more each month toward the principal, if current rates are lower than what you have on your existing mortgage, you could opt for a cash-in refinance and/or move from a 30-year mortgage to a 20- or 15-year instead.

You don’t have a prepayment penalty. When you refinance, you’re actually paying off one loan and taking out another. Although Johnson Bank doesn’t charge extra for early repayment of a loan, some lenders do. If your lender does assess a fee, make sure it’s less than the amount of money you’ll save over time.

You have an adjustable rate mortgage (ARM). ARMs make it more difficult to budget for future mortgage payments because your required payments fluctuate, particularly if you start out with rock-bottom rates that balloon after a period of time. Fixed rates have a more consistent repayment schedule and may provide a lower overall rate.

You plan to stay in your current home for at least another two years. You may not have time to recuperate the costs associated with refinancing if you’re planning to move in the next two years, and you may take a hit on the equity you could have available to put toward that next home.

Your credit score has improved. If you’ve worked over the past year or two to bring up your credit score, especially if it used to be below 700 and is now 780 or higher, you could qualify for a better rate than what would have been available to you previously.

You’ll be able to qualify. Even though you’re refinancing a current loan, it’s still viewed as a new loan. Your home’s current value, the loan-to-value ratio, the amount of equity available, your credit score and your debt-to-income ratio will all be taken into consideration.

The best place to start the refinancing discussion is with your current mortgage loan officer. He or she will let you know if you’re in a solid position to consider refinancing now or if it’s something to keep in mind for the future.

* A cash-in refinance is when the principal balance is reduced by paying extra money at closing; cash-out refers to those who increase their loan balance by at least 5% to have extra cash on hand after closing. According to Freddie Mac, 46% of homeowners who refinanced a first-lien home mortgage in Q4 2010 paid in extra money at closing to lower their principal balance, the highest percentage to do so since refinancing pattern records began being kept in 1985; “cash-out” borrowers accounted for 16%, a drop from the 25-year average of 62%.

SOURCE: Freddie Mac News