If interest rates are now lower than when you locked in your mortgage, you might be considering a refinance. Home refinancing can save you thousands of dollars over the life of your loan. If you are lucky enough to have equity in your home, you can take out a home equity line of credit or HELOC.
The old-fashioned rule says that a refinance only makes good sense if you can lower your current mortgage interest rate by about 2%, for example from 6.5% to 4.5%. While this is true in some cases, it also depends on how long you plan to stay in your home. The longer you stay in your house, the smaller the percentage point difference can be to still make it worthwhile.
If you have a $200,000 mortgage with a 30-year term at 6.5% interest, your monthly payment of principal and interest would be $1,264 – before property taxes and insurance. If you refinanced at 4.5% your new monthly payment would be $1,013 – for a savings of about $250 per month. If the closing costs are approximately $4,000 it would take you 16 months to recover that expense. If you plan to remain in your home about 2 years, then refinancing in this example case is probably a good idea.
There are a few factors other than the annual percentage rate (APR) that are also important. The term of the mortgage is a factor. Short-term mortgages will pay off your loan faster but you’ll have much higher monthly payments. Mortgage interest rate variability is another factor. Adjustable rate mortgages (ARMs) generally offer a low introductory rate but they could jump in the future. If you plan to sell before the ARM resets, then it might not matter to you.
Discount points are fees you pay to a lender at the close of escrow (COE). Typically these points are paid in exchange for a lower interest rate. If you plan to live in your home for a long time, then paying points could be favorable. One point is equal to 1% of the value of the loan and will buy down the loan interest rate by 1/8th%. So if you have a $200,000 mortgage and wish to buy down the interest rate by ¼% then it would cost you $4,000 to do so.
Home Equity Line of Credit (HELOC) works a little differently. They are loans established as a line of credit with a maximum draw amount. You can draw down from this loan via a checkbook, special credit card or bank wires. Draw periods are typically 5 to 10 years and the interest rate on a HELOC is usually higher than a mortgage rate. Because your HELOC balance may change daily, the interest rate is calculated daily rather than monthly.
