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Home Refinancing Basics

Couple at kitchen table reviewing home refinance paperwork
Buying your first home is one of the most enjoyable and sometimes complicated times in a person’s life. You are celebrating a milestone and taking a big financial step at the same time. The next question you might ask is how to refinance your home. It may be worth your time to run the numbers and see if refinancing your mortgage at a lower interest rate or for shorter term is a wise move.

What is Refinancing?

Refinancing replaces your current mortgage with a new mortgage. Most homeowners refinance to lower the interest rate or shorten the term of their mortgage, allowing them to lower their monthly payment or pay off their mortgage faster.

If you’ve owned your home for a while and your home’s value is higher than your current mortgage balance, you may also be able to obtain a cash out refinance. Using the equity in your home, you can get funds to renovate or improve your home or pay down high-interest debt.

What is the Average Cost to Refinance?

Similar to when you obtained your current mortgage, there are lender and third-party fees and other costs associated with a refinance, such as an origination fee, appraisal fee and closing costs, although refinance costs are generally less than costs associated with purchase-money mortgages.

While there is not a standard method to calculate the cost of refinancing your mortgage, the amount you will pay depends on your lender and the location of your home as closing costs vary from state to state. Some lenders allow you to “buy” a lower interest rate by paying “points”, or an up-front fee. Some offer a “no cost” or “zero points” mortgage which reduces the expense of refinancing, but keep in mind, the interest rate will likely be higher and therefore your monthly payment will be higher.

Is it Cheaper to Refinance with My Current Lender?

Your current mortgage lender may be able to offer you cost effective refinance options and may be able to expedite the application process, however it is always best to contact other lenders and compare the rates, terms and costs available.

Should You Refinance Your Mortgage?

More than half of all new mortgage loans in recent years were refinances. Depending on your current mortgage’s interest rate, you may be able to refinance at a lower rate. You will want to determine if the savings from a lower interest rate will cover the cost of refinancing itself. For instance, if you don’t plan to live in your home long enough to break even, refinancing may not be the right choice for you.

 

Take the Following Example:

Icon for Take the Following Example:
Icon for Take the Following Example:
If you have a 30-year mortgage for $200,000 with a 6.5% interest rate, your monthly payment would be $1,264.
If you refinanced at 4.5%, your new monthly payment would be $1,013, a savings of $251 per month.
If the closing costs for the refi amounted to $2,000, it would take eight months to break even. ($251 x 8 = $2,008).
You will need to stay in your home for at least eight more months to cover the refinancing costs.
If you think you might have or want to sell the house before then, refinancing may not be the best option.
Refinancing has the potential to help you reduce costs associated owning a home, but it’s not a strategy that makes sense for every homeowner. Before you make a commitment to refinance your mortgage, do your homework and determine whether such a move is the right one for you. In other words, make sure you consider the amount of time it will take for your monthly mortgage savings to compensate for the cost of the refinancing.
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I hear the 1% rule of thumb, but remember that like any rule of thumb, it’s just a starting point.
Jules Deas, SouthState Mortgage Sales Manager, says refinancing can be worthwhile if you can lower your interest rate even a little. “I hear the 1% rule of thumb, but remember that like any rule of thumb, it’s just a starting point. If your mortgage balance is low, sometimes 1% or even 2% may not make sense. However, if you have a higher mortgage balance, occasionally as little as a half a point will be worthwhile,” he explains.

Don’t make the mistake of choosing a mortgage based only on the interest rate. With interest rates at historical lows, refinancing to a shorter-term mortgage may make sense, such as a 20 or 15-year term rather than the traditional 30-year. While a shorter-term can significantly reduce interest costs over the term of the loan, the principal portion of the monthly payment will be greater because there is less time to pay off the loan. You’ll need to take into consideration whether you have the cash flow to cover a higher monthly payment.

Things to Remember Before Refinancing

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Icon for Things to Remember Before Refinancing
  • Refinance only if the long-term savings outweigh the initial expenses. To calculate your break-even point, divide the cost of refinancing your mortgage by your monthly savings. The resulting figure represents the number of months you will need to stay in the home to make the strategy work.
  • Don’t select a new mortgage based only on its annual percentage rate. Consider the length of the loan, whether the interest rate is fixed or variable, and the relative merits of paying up-front fees (points) in exchange for a lower rate.
  • Start by speaking to your current lender about refinance options, then shop around, crunch the numbers, and ask questions. Find a SouthState Mortgage Banker to talk about your options.

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