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Mortgage Refinancing to Lower Interest Rates

As markets shift and individual circumstances change, it may become possible to get a better, lower interest rate on your mortgage. This is by far the most common motivation behind refinancing, as well as the easiest to understand and take advantage of.

The general rule of thumb on interest rates is that to be worthwhile, you should aim for a reduction of at least 1.5 percent. So if your original mortgage was at 5 percent, you probably want to wait for rates to drop to around 3.5 before you can really enjoy the benefits of refinancing, and save more than you will spend on closing costs and related fees. Once the rates in your area cross that threshold, you can pursue a mortgage refinance to enjoy numerous benefits that result from a lower interest burden.

How it can help:

  • Lower Monthly Payments

Lower interest means lower monthly obligations. Although the interest rate won’t affect your insurance or taxes, it can still provide some upfront relief to your monthly bills. Depending on when you originated your mortgage, as well as what the market looks like in your area, this variable alone could make refinancing a fantastic option for you to save.

  • Escape from Adjustable Rates

One of the most common reasons people refinance has to do with one of the most common types of mortgage: the Adjustable-Rate Mortgage, or ARM. Under this arrangement, your interest rate--and your monthly bill--can vary widely and suddenly inflict painful uncertainty into your home finances. Refinancing into a Fixed Rate mortgage can help avoid this uncertainty and save money. Planning ahead can help you switch over before your rate ever goes up; then you never have to worry about rate changes again.

  • Increase Cash On Hand

Paying less to your mortgage every month could open up other savings or investment opportunities for you. If eliminating your mortgage debt isn’t your top priority, the money you save with a lower interest rate could end up paying dividends if you have an investment strategy for it. Of course, more cash on hand can also just mean more spending money in the short term--it just depends on your priorities once you get locked in to your lower interest rate.

  • Pay Off Debt Faster

This is a popular strategy for debt-conscious homeowners who refinance. After you get your interest rate reduced, continue paying the same monthly amount you were under your old mortgage terms, and you effectively pay extra every month. Your bills will look the same as before, but you will actually be getting ahead every month! Better yet, specify to your lender that you want the difference applied to your principal, and you can gain equity faster and reduce the net interest you will pay even further.

What to Look For:

No matter what your specific goals are, taking advantage of lower interest rates really boils down to paying attention to your local market and being prepared when you see rates drop. Remember: the rule of thumb is to aim for a minimum of 1.5 percent lower interest, but you will still want to take other factors into consideration, such as:

  • How much of your original mortgage you have paid off?

  • Has the value of your property changed since you purchased it?

  • Have you maintained or improved your personal credit score?

  • Can you afford the closing costs up front to take advantage of the new interest rates?

You can use a simple calculator to determine how long it will take for the interest savings to make up for the costs of refinancing. This is your break-even point, and is a helpful starting point for determining if and when you should talk to a lender about refinancing.

Watch Out: There is no such thing as a No-Cost Refinance. This term is just shorthand for when the lender agrees to pay the closing costs and associated fees upfront on your behalf, in exchange for a higher interest rate. Refinancing means starting over with an all new mortgage, and although you won’t have to pay a realtor again, closing costs can still add anywhere from 2-7 percent or more to the total cost of the new mortgage. Getting locked into a better interest rate can offset these costs in the long run, but they may still be a burden in the short term. Lenders know this, and offer No-Cost options to help lower the closings costs, but this really turns the upfront closing fee into an accumulating expense over the life of the new mortgage.

You may decide that taking this long-term add-on to the costs of your new mortgage are worth it to get the lower rate. But if you goal is to get the lowest possible interest rate on your mortgage, then you will need to plan very carefully to cover your closing costs, and avoid any alternative payment options that could end up inflating your bottom line through added interest. It may

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