Millennials have taken over as the largest group of home buyers in the U.S. While people in this age group are in their 20s and early 30s now, by the time their mortgages are paid off, they will be nearing retirement. This change in circumstances is a reminder of why it often is not the best idea to stick with the same mortgage for its entire term - you should regularly think about optimizing your mortgage.
A 30-year mortgage spreads the loan out over a long period of time and thus makes the home more affordable. However, the affordability of that mortgage relative to other alternatives can change over the course of 30 years. As a result, what was the optimum mortgage when you were 30 might not fit as well by the time you are 45. That's why it makes sense to periodically think about refinancing, even if a dramatic fall in bank rates does not create an obvious opportunity.
Costs to consider before refinancing your mortgage
Any talk of refinancing has to acknowledge one important reality - refinancing costs money, in the form of closing costs on the new loan. You should also be aware of any early prepayment penalties on your current mortgage before you decide to refinance.
So, when thinking about the reasons for refinancing, you should take into account how the expense of closing costs compares with any long-term benefits from refinancing.
7 financial scenarios that can impact your mortgage
A lot can change in the 30 years it takes to pay off a mortgage. Here are some examples, and how these changes can affect the ideal mortgage type for your situation:
1. Interest rates fall
Low mortgage rates in recent years prompted a massive wave of refinancing, but often the opportunity to capture lower interest rates is not so long-lasting. Mortgage rates can be volatile, and a sudden downward spike might not last very long. This is why you should always have a rough idea of what your refinancing threshold is - the interest rate that would make it worth paying the cost of refinancing. That way, you will know what to look for and be ready to act quickly.
2. Interest rates rise
It is difficult to think of a circumstance that would make you want to refinance after rates had already risen, but if you anticipate a rise in rates, it would certainly call for adjustable rate mortgage borrowers to switch to fixed-rate loans.
3. The difference between long and shorter term mortgage rates widens
Shorter loans typically offer lower rates, but how much lower varies over time. As the gap gets wider, you might have more to gain by refinancing into a shorter mortgage. Especially if you have already paid down enough of your principal to make the payments on a shorter loan affordable.
4. Household earnings increase
If you get a significant raise or add another wage earner to your household, it could mean that now you can easily make your monthly mortgage payments with room to spare. In that case, consider refinancing to a shorter term mortgage loan. Not only might you be able to take advantage of a favorable spread between long and shorter rates as described above, but cutting years of interest payments off your mortgage loan is likely to save you money in the long run.
5. Household income decreases
In the opposite case, where household earnings take a hit, you might consider lengthening out your loan term. For example, if you have 25 years left on a 30-year mortgage, you might consider refinancing to a fresh 30-year loan. Unless mortgage rates have risen dramatically, this should reduce your monthly payments to make them more affordable on your reduced income.
6. You pay off another debt
Paying off your student loan or other debt is essentially like getting a raise. It leaves you with extra money to put towards your mortgage, so you can consider a shorter loan to reduce interest expense.
7. You plan to move in a few years
Adjustable rate mortgage rates are usually significantly lower than fixed rates, but they carry the risk of rising. However, that risk is mitigated if you plan on moving in a few years. Those plans may make it worthwhile to refinance to an adjustable rate loan.
More often than not, interest rate changes are what prompt people to refinance their mortgage loans, and certainly a drop in rates can make it easier to overcome the cost barrier. However, even absent a change in rates, there are plenty of changes to your personal circumstances that make it necessary to look at refinancing.
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