Refinancing your mortgage can make good financial sense, as long as you are doing it for the right reasons. Before considering a refinance, it’s worth spending some time to assess what your financial goals are.
Lowering Your Interest Rate
One of the most common reasons to refinance a mortgage is to take advantage of a lower interest rate. Because mortgages are long-term loans, even a slight drop in the interest rate on the loan can make thousands or even tens of thousands of dollars of difference over the life of the loan.
Before refinancing to get a lower rate, you’ll want to ensure that you will stay in your house long enough to reap the benefit of the lower payment. For example, if your refinance is going to save you $50 a month and your closing costs are $3,000, you would need to stay in your home at least five years just to break even.
A Shorter Loan Term
Another common reason people refinance their mortgage is to shorten the term of the loan. Though a 30-year loan gets you a much lower monthly payment, you wind up paying much more in interest over the term of the loan. If interest rates drop significantly, you might be able to refinance into a 15-year loan and only pay a couple hundred dollars more a month, which, if you can afford it, will mean you pay off your house much faster and pay significantly less in finance charges. But is this best for you?
Moving From A Variable To Fixed Interest Rate
If you got a loan with a variable interest rate, you likely will want to refinance at some point into a fixed-rate loan. When you do so, however, you want to make sure you are getting a better deal. If interest rates look like they are going to increase, that would be a good reason to move to a fixed-rate loan.
Getting Rid Of Mortgage Insurance
If you put down less than 20 percent of the purchase price of your home, you likely had to get mortgage insurance. Depending on the insurance policy and how quickly your home appreciates in value, it might be beneficial to refinance at some point if you have enough equity in your home to drop the mortgage insurance.
Switching From FHA To Conventional
Given that FHA mortgages now carry mortgage insurance premiums for the life of the loan, it makes a lot of sense for borrowers to switch away from them when they can. Refinancing may be possible once the homeowner has built up enough equity to qualify for a mortgage from a traditional lender, without the burden of mortgage insurance.
ARM Coming Up On Adjustment
The low rate of an adjustable rate mortgage sticks only for the first few years of the mortgage. After this point, the rate adjusts each year based on market trends.
Rather than paying the adjusted rate, which is almost always higher, homeowners can refinance into a new fixed rate mortgage to lock in one of today’s low fixed rates for the duration of the mortgage.
Cash Out To Consolidate Debt
Homeowners carrying high-interest debt, like credit cards and personal loans, can often benefit from consolidating it into their mortgage. As long as they maintain at least 20 percent equity in their home, they can get a cash-out refinance for an amount higher than their current mortgage balance.