Have you heard a lot about refinancing lately? Are you wondering if refinancing your own mortgage makes sense?
To figure this out, it's a good idea to first understand what refinancing is. According to a mortgage refinancing guide published by the Federal Reserve System, the central bank of the United States, "When you refinance, you pay off your existing mortgage and create a new one."
And there are many reasons to refinance, says Todd Huettner, a mortgage broker at Huettner Capital in Denver, Colorado.
"People refinance to lower their interest rate, obtain equity from their property, or go from an adjustable rate to a fixed rate," Huettner says.
Think refinancing might be in the cards for you? Keep reading to learn about more smart reasons to refinance.
Reason #1: You Want a Lower Interest Rate
You may have heard that mortgage rates are at an all-time low. But what does this mean to you?
Potentially big savings, that's what it means.
Just consider this: As of October 25th, 2012, the average 30-year fixed-rate mortgage had a 3.41 interest rate, according to a press release published by the Federal Home Loan Mortgage Corporation (also known as Freddie Mac).
And scoring a lower rate mortgage could add up to considerable savings over the life of your loan, according to Andrew Schrage, editor of the consumer savings site, MoneyCrashers.com.
Schrage offers this example to help illustrate the potential savings: "If you're five years into your 30-year fixed mortgage, with a current loan balance of $200,000 at 5.5 percent, by refinancing to a 3.375 percent interest rate, you could lower your monthly payment by approximately $250," he says.
Reason #2: You Can Afford a Higher Monthly Payment
Let's say you just got a long-term job promotion and it came with a hefty pay increase. You could treat yourself to a new car or a new wardrobe, but why not invest that money in your home?
"The benefits of refinancing are not only for those looking to cut their monthly payment," says Schrage. "If you can afford a slightly higher payment, you can save a bundle by refinancing to a 15-year fixed term."
And refinancing from a 30-year fixed to 15-year fixed loan is a big, money-saving trend, says Huettner.
"People are extremely motivated to reduce debt," Huettner says. "Far more people are shortening the term on their loans and trying to get out of debt as soon as possible."
Shortening the term of your loan generally means you'll have a lower interest rate, too, according to the Federal Reserve. And this could help you save a good chunk of change in the long run.
To highlight the potential savings, Schrage gives an example of someone who is five years into a 30-year fixed mortgage at 5.5 percent, with a current loan balance of $200,000.
"By switching to a 15-year fixed at 2.5 percent, your monthly payment goes up by $200, but you save almost $100,000 over the remainder of the mortgage," he explains.
With this example, refinancing to pay a little extra month seems worth it, right?
Reason #3: You Plan to Stay in Your Home for the Long Term
How long do you plan to stay in your home? If your answer is "not much longer," then it might not make sense for you to refinance.
Why? Because when you refinance your mortgage, it includes closing costs, which can amount to 3 to 6 percent of the loan, according to the Federal Reserve.
And if you decide to move soon after you refinance, then the refinancing costs may outweigh the savings.
On the other hand, if you plan to stay in your home for the long term, it could make sense to refinance into a low-interest rate loan, says Gloria Schulman, founder of Southern California mortgage lender, CenTek Capital Group.
"This could be an especially attractive option for young borrowers, who can lock themselves into a 30-year fixed mortgage at rates they may never see again in their lifetimes," says Schulman.
Reason # 4: You Want to Get Out of Your Adjustable-Rate Mortgage (ARM)
If you have an adjustable-rate mortgage (ARM), your monthly payments fluctuate as the interest rate changes. "With this kind of mortgage, your payments could increase or decrease," the Federal Reserve notes.
And if they go down, that's great. But if they go up…well, your bank account could take a hit.
Now, if you're not a fan of unpredictability, this type of loan could be a bit unnerving. And if you're looking to get out of it - and lock in a low fixed-rate loan - refinancing your mortgage could help you do just that.
Before you do this, however, one thing to consider is that ARMs "may start with lower monthly payments than fixed-rate mortgages," notes the Federal Reserve's handbook on ARMs.
With that in mind, refinancing to an ARM with better terms (like a lower interest rate), could be a good idea, "especially if you can pay off the house within 10 years," says Schulman. "Rates for 5- to 7-year ARMs are at historic lows," she says, "and no one is expecting rates to rise at all until at least 2014."
Deciding on which mortgage type is right for you is a big financial decision, which is why the Federal Reserve recommends asking a lot questions about the loan features.
"And keep asking until you get clear and complete answers," the Federal Reserve adds.