If you have a good credit rating but are currently paying a higher than desirable interest rate on your mortgage, consider refinancing. That means…
…taking out a new home loan at a lower rate and using some (or all) of the proceeds to pay off the existing one.
What’s the point of refinancing?
Basically, so you can score a better deal on your mortgage, allowing you to …
- Lower your monthly mortgage payment
- Shorten the length of your loan (for example, cut the timeframe from 30-years to 15-years)
- Provide capital for home improvements, debt consolidation or college tuition, if you opt for a cash-out refinancing
When should you refinance?
Some wait until interest rates drop two percent points lower than their current rate; others refinance when it hits a one to one-point-five percent differential.
Other factors to consider include how much longer you plan on staying in your home, the equity you’ve built in your home, and the costs associated with getting a new loan.
How do you refinance?
Two options are available to you:
- No cash-out refinancing is when the amount of your new loan does not exceed your current mortgage debt.
- Cash-out refinancing is when you borrow more than you owe on your existing mortgage.
On the one hand, cash-out refinancing will give you a better interest rate. Plus, the interest paid on your refinanced mortgage will most likely be tax-deductible. But your lender could foreclose on your home if you fall behind on your mortgage payments.
Are there tax advantages of refinancing?
That depends. A point equals one percent of the loan amount. If you pay for lender points up front, as a form of “pre-paid” interest in return for a lower interest rate, they’re deductible. If points are wrapped up in the general administrative costs of obtaining the loan, then no – they’re not deductible.
For more information on the deductibility of points, you can refer to IRS Publication 936.
The biggest question to ask yourself:
‘Will I be able to recoup the cost of refinancing my home…while I actually own the home?’
To determine the answer, you’ll need to weigh the costs of refinancing against how long it will take you to recoup your costs.
- If you don't stay long enough to recover your costs, refinancing is a bad strategy.
- The longer you stay past your break-even point, the more you'll tip the balance in favor of refinancing.