The right way to refinance

The main reason to refinance is, of course, to save money. If you get a better interest rate with refinancing, you can reduce your monthly payments. Besides, even the smallest reduction in your rate can add up to significant savings in the long run. There are four main monetary advantages to a mortgage refinance.

Lower your monthly payment: By exchanging a higher interest rate for a lower one, your monthly mortgage payment will be automatically reduced. You can also achieve this by changing from one type of loan to another. For instance, moving from a fixed rate to a variable rate will help you save every month, every quarter or every year, based on how your bank or mortgage provider positions it.

Stabilise your monthly payment: If you have a variable rate mortgage and your initial interest rate period is about to end, you can refinance to a fixed rate that may save you money over time. The interest rate on a variable rate mortgage can keep climbing, but a fixed-rate loan will help you budget better. You will know exactly how much you have to pay out for the next 15, 20 or even 25 years.

Put some cash back in your pockets: Refinancing can allow you access to some of the equity you have built up in your home. It could become the source of funds for a renovation or addition, paying big bills, buying a new car or financing your child’s education. You can also get extra funds by a cash-out refinancing: this is done by drawing on your equity by borrowing more than you currently owe. It can be cheaper than taking a home equity loan or a second mortgage, which generally carry higher interest rates.

Make debts more manageable: If you have enough equity in your home to cover other debts, refinancing may work to your advantage, as you can use the cash to settle other large debts such as car loans and credit card payments, which have higher interest rates.

Plan of action

Two things can help you determine a plan of action: your current mortgage rate, and how long you plan on staying in your home.

Evaluating your mortgage’s interest rate against prevailing rates is a good place to start. The fundamental rule for refinancing is that current interest rates must be at least two points lower than your existing mortgage. The decision should also weigh the savings of a lower monthly payment against the new costs associated with the refinancing process. If you are lucky, you may be able to refinance without incurring too many charges, but this may result in a slightly higher rate. Remember, refinancing will only work in your favour if the total package falls below your current interest rate.

Although it may sound unrelated, the period of time you plan to live in your home is also important. You must be sure of spending at least five years in your home so that you can enjoy the savings gained from refinancing it. Mortgage refinancing often has hidden costs, and if you sell your home in less than five years you are less than likely to recover them, or recoup your initial expenses. On the other hand, with long-term plans, you will be able to reduce your monthly payments with a lower interest rate, shorten the term of your mortgage, or even get cash back.

When you are applying for a mortgage, the ideal solution is to get the lowest fixed rate in the market. But when you are looking at refinancing options, the type of mortgage you have matters. If you are in the first year of a five-year variable rate mortgage and are planning a change, it will make no sense whatsoever. However, if the variable rate is about to rise, it will certainly make a difference to move to a fixed-rate mortgage.

Historically, interest rates go up faster than they come down. So if you are thinking about refinancing your mortgage, get the best rate now. But be warned that a near-future drop in rates may not be drastic enough to impact your monthly payments.

Hidden charges

Very few mortgages have no closing charges. Sometimes, to suit a specific requirement, banks or institutions may waive their application fees or agree to absorb the appraisal fees, but in these instances, they are likely to increase the interest rate. Technically, these arrangements may be called mortgages with no closing charges, but they are not really so.
The cost of refinancing a mortgage is quite similar to the cost of your original mortgage. There will be fees for legal services, title searches and transfers, surveys, and property appraisals, among others. A good way to minimise these fees is by dealing with your original bank or lending institution, since they already have all your original paperwork. Remember though that they are under no legal obligation to renegotiate, so getting out of your original mortgage may carry a penalty, even if it has a prepayment option built into it.