There are a few main reasons why people consider refinancing their mortgages. You need to consider what your main goal is with refinancing. If there is a lower interest rate than you currently have on your mortgage, if you wish to lower your mortgage payment, or wish to pull cash out — refinancing may be a good option.
These are the types of scenarios that you need to consider prior to pulling the trigger. You need to understand all that refinancing involves since your home is most likely your most valuable asset. Refinancing can allow for some great benefits if you handle it correctly, but it does come with associated costs.
What Is Refinancing?
Refinancing mortgage is the process when we agree on a new loan contract with new terms and conditions. When you refinance your home, this is the process it takes to make changing to your existing mortgage. When you refinance your mortgage, the old mortgage is paid off by the bank or lender.
This When Should I Refinance My Home?
There are many reasons why someone would want to refinance their mortgage. Perhaps you had less favorable terms when you originally received the loan and you want to take advantage of better rates. There are many reasons to refinance, here are some of the most popular.
Lower Your Interest Rates
Interest rates are directly related to how much you pay on your mortgage every month. As you can guess, the lower the interest rate, the lower your monthly payment is. It is possible to get a lower interest rate if the market conditions change. The benefit of a lower interest rate is that in addition to lower payments each month, you also get to build equity in your home quicker.
As an example, let’s say you have a 30-year fixed-rate mortgage of $150,000 (assuming 20% down payment). Let’s compare the principal and interest payments if we change the interest rate just 1% (from 5% down to 4%):
- Monthly payment at 5%: Approx. $645
- Monthly payment at 4%: Approx. $573
- Monthly difference: $72
- Yearly difference: $864
- Over 30-year mortgage term: $25,920 saved in interest alone!
Adjust The Mortgage Terms
You can change the terms of the mortgage as well, either shortening or lengthening them. Lengthening your terms will add to the total amount of interest that is owed. However, this will lower the amount you pay in your monthly payments.
The real advantage of changing the terms is to shorten your loan period. Shorter loan terms mean you can pay off the loan quicker and shorter loans typically have lower interest rates as well. Since the time period is shorter, you most likely will have a higher monthly payment, but the total amount of interest that you will have paid will likely be reduced significantly.
As an example, let’s say that we take that $150,000, 30-year fixed-rate mortgage and convert it to a 15-year fixed-rate mortgage (at a slightly lower interest rate). The payments, as well as the interest you would pay over the lifetime of the loan, are shown below:
- Monthly payment for a 30-year loan at 5%: Approx. $645
- Monthly payment for a 15-year loan at 4.5%: Approx. $920
- Total interest paid on the 30-year loan: Approx. $111,906
- Total interest paid on the 15-year loan: Approx. $45,239
- Difference in interest paid: $66,667
Consolidation Of Debt
If you have several debts that you would like to consolidate or get under one low-interest payment, you can do so with cash-out refinancing. You may have high-interest debt, for example, student loans, that you wish to pay off to avoid extra monthly payments. This can be accomplished by tapping into the equity of your home.
Upon refinancing, based on the equity you have within your home, you gain access to a certain amount of cash. You can use this cash to restock your emergency funds, make home improvements, or to pay off debts and consolidate them into one lower interest mortgage payment. If you want to have one low interest but slightly higher mortgage payment, as opposed to several higher interest payments, refinancing can help you accomplish this.
Pros And Cons Of Refinancing
We have highlighted when someone should look to refinance above, but are all of these situations good for you in the short or long term? Let’s review what the pros and cons of refinancing are below.
Pros Of Refinancing Your Mortgage
There are many benefits of refinancing that can lessen the burden on your personal financial situation. Some of the main pros include:
- Can take advantage of lower interest rates that the marketplace offers (less paid monthly and over the whole loan agreement)
- You have access to the equity you have built-in your home to pay off debts or whatever you see fit
- Have the ability to lower the number of years required to pay off your home
Cons Of Refinancing Your Mortgage
There are a few downsides to refinancing that you need to evaluate and consider when making this decision. Some of the cons include:
- The interest rate may not save very much (depending on your current interest rate and the rates you can find with lenders)
- Fees associated with refinancing can be high
- Refinancing takes time to complete – could be longer than you were originally expecting
- Can be preventative of moving within the next few years if you refinance (equity will be taken out)
Are You Eligible For Refinancing?
Are you eligible for refinancing, and more importantly – does it make sense for you and your family? A lender will review your current finances, your credit score/history, debts, the property value of your home as well as the amount you want to borrow.
Lenders will take a look at your loan-to-value ratio, also known as “LTV,” to see if you fall within the specified guidelines. If the amount you are requesting to borrow meets the appraised value, the lender may deem you eligible for a loan. If your LTV doesn’t fail within their guidelines, you may not be eligible for a loan, or you may be offered one with less preferable terms than you currently have.
It is best to ask an expert to see if you are eligible for refinancing and what benefits you can take advantage of.
This page last updated: March 21, 2022