When it comes to refinancing, securing a lower interest rate isn't always a good enough reason to sign up for a new loan. Stay true to your goal of debt reduction by asking yourself the following questions in order to determine if refinancing will save you money.
1. Why are you refinancing?
Wanting to refinance in order to take advantage of lower interest rates so you can save money is a valid reason. If, however, you wish to refinance in order to pull out money to spend on nonessentials, then refinancing is a bad idea that will have a negative impact on debt reduction.
2. What is the difference in interest rates?
Depending on the amount of your loan, a 1 percent interest-rate deduction may not be sufficient to warrant refinancing because it will take you several years to recoup the closing costs. A significant decrease in interest rates, such as 2 percentage points or more, may make refinancing a wise move.
3. How long do you plan to stay in your home?
If you plan to move in the next year or two, refinancing is generally not recommended because you won't be staying put long enough to recover the closing costs. When you plan to own your home for five years or more, refinancing is often a good idea. Ask a lender or use an online calculator to determine how long it will take you to recoup refinancing costs.
4. How much equity do you have?
When you refinance, you forfeit the years you spent paying off the loan. So if your 30-year loan is down to 22 years, it will go back up to 30 years once you refinance, unless you opt for a different loan term. On the other hand, if you have little or no equity in your home and can lower your interest rate by refinancing, then doing so is probably your best choice.
Deciding whether to refinance is a decision that directly affects your ability to get out of debt. Ask yourself these questions and consult a lender to help you determine if this financial move is your best option.
About the Author:
Julie Bawden-Davis is a Southern-California-based writer specializing in personal finance and insurance. Since 1983, her work has appeared in a wide variety of publications, including Family Circle, Ladies' Home Journal, Parenting, Entrepreneur and The Los Angeles Times.