Refinancing your mortgage can take some work, but your investment of time and money can pay off big-time if you have a good reason to do it. Below are six common reasons homeowners look to refinance.
Lower your mortgage rate
Grabbing a lower rate when market interest rates are rising can be difficult or impossible, depending on how low your current rate already is. But there are other ways to lower the rate you’re paying. One approach is to improve your credit score – assuming it was lower when you first got your loan. Refinancing could help you stop paying a higher rate due poor credit habits you used to have and instead secure a lower rate as a reward for better credit habits you’ve developed since then.
Lower your mortgage payment
If you’re struggling to afford your payment, refinancing to extend your loan term might give you some relief. If you refinance, your new rate might be higher than your current rate and you might pay more interest expense over the entire term of your new loan. Still, refinancing could make sense if your other options are late payments, missed payments, damaged credit scores and potentially losing your home in a bank foreclosure.
Pay off your mortgage sooner
Refinancing a 30-year mortgage into a 15-year term could help you pay off your loan sooner. You might get a lower rate, though your payment likely will be higher. A 15-year loan could also reduce your interest expense over the entire term of your new loan. An alternative strategy is to accelerate payment of your existing loan WITHOUT refinancing. This tactic could allow you to pay off your loan sooner without giving up the flexibility of your longer term and lower payment.
The comparison between a 30-year loan you already have and a new 15-year loan can be complicated. You’ve probably already made payments for at least a handful of the 30 years, and paying less in interest could affect your income tax liability. Do the math before you make this decision.
Eliminate rate risk
If your existing mortgage has an adjustable rate or you have a hybrid loan that will convert from a fixed rate to a new higher or variable rate in the near future, you’re exposed to the risk of a higher rate and payment. Refinancing from an adjustable-rate mortgage (ARM) or hybrid loan into a fixed-rate mortgage eliminates that rate risk. Your new rate and payment likely will higher, but you’ll be safe from further increases that might be even more painful in the future.
Free up equity for other opportunities
Equity in your home is an asset you can leverage by refinancing and taking out cash for other needs, wants or investment opportunities. One popular reason to refinance with cash out is to make repairs or improvements to your home. A new roof, room addition, kitchen remodel or other upgrades might make your home nicer for you and your family and you might be able to recoup all or part of the cost when you sell your home. Home equity also can be used to consolidate other debts, finance your children’s or grandchildren’s education, start your own business or splurge on a once-in-a-lifetime wedding or vacation, among other ideas. Alternatives to a cash-out refinance include a home equity loan or home equity line of credit (HELOC).
Stop paying mortgage insurance!
If you bought your home with a downpayment of less than 20 percent of the purchase price, you might be paying for mortgage insurance every month when you make your payment. Mortgage insurance protects your lender from all or part of the loss if you don’t repay your loan. Some types of loans allow you to stop paying for mortgage insurance when your equity builds up to a certain level. Other types of loans require mortgage insurance as long as you keep that loan. Refinancing might rid you of mortgage insurance or lower its cost.
Before you decide to refinance, you should contact several lenders and compare the different combinations of rates, payments and closing costs they’re willing to offer you. Ask for a Loan Estimate Form for each option you want to consider and try to make apples-to-apples comparisons. If the costs outweigh the benefits, refinancing will be an obvious no. If the benefits are clear and the costs seem reasonable, refinancing your home mortgage could be an easy yes.
Ever wonder how your equity impacts your next home purchase?