Refinancing your mortgage can be worth it if you can save money on your monthly mortgage payments. What else is in it for you? When you refinance your mortgage, you can shorten the term of the mortgage, tap into home equity, or get money to pay unexpected bills. But timing is everything. The key to saving money when refinancing your mortgage is doing it at the right time.
There’s no such thing as one-size-fits-all. Mortgage refinancing is not always the best solution to giving your finances a boost. A lot of people make the mistake of viewing their home as a bank or credit card they can use to withdraw money. And mortgage refinancing is one way to get money out of your home. But it can hurt your finances in the long-run. In some cases, you can end up paying for your mortgage longer than expected. Or the overall cost of the mortgage may become more expensive if you choose to refinance.
Before you decide that you should refinance your mortgage, you need to consider your long-term financial obligations. You also need to take into account your current financial situation. For example, your current credit score, costs of refinancing, your home’s equity, and interest rates can help you decide if refinancing a loan is worth it.
In this article, we’ll explore the pros and cons of refinancing a mortgage. You’ll find out when it’s the right time to refinance and also why maybe you shouldn’t.
What is Mortgage Refinancing?
The US Government website says that mortgage refinancing means replacing your existing mortgage with another one under new terms. In other words, you swap the current mortgage for a new one, known as a “refinance.” A mortgage refinance may change any combination of your interest rate, monthly payment amounts, or loan payoff date. The goal of refinancing any long-term loan like a mortgage is to use the new loan to pay off the old one. In ideal circumstances, the terms of the new loan will be better and save you money in the long-run.
Some types of mortgage refinancing allow you to enjoy new, lower interest rates. Other refinancing options involve a mortgage for a larger amount to convert home equity into cash. This is sometimes called “cash-out refinance.”
Reasons Refinancing a Mortgage is Worth it
What are some of the reasons when refinancing your mortgage makes sense? Here are some factors to consider.
Refinance a mortgage to get lower interest rates
The best reason to swap your current mortgage for a new one is to get a lower interest rate. When mortgage interest rates fall, you may save money by refinancing. According to Bankrate, you should look into refinancing if you can save half a percent or more on your rate.
Getting a new mortgage with lower interest rates means it will work out cheaper in the long-term. Also, lower monthly payments means that you have more money for your family’s budget. In some cases, the difference in monthly payments can be over $100.
Before you refinance a mortgage due to lower interest rates, you should take into account how long you will stay in your home. Refinancing makes the most sense if you are planning to stay in your home for a few years. If not, you may not get back the cost of investing in a new mortgage.
Refinance to a fixed-rate or adjustable-rate mortgage
Many first-time buyers take out adjustable-rate mortgages (ARM) as they typically offer you a lower interest rate. At least, when you first take out the loan. On the other hand, some home buyers prefer taking out fixed-rate mortgages as it locks in the interest rate for many years.
However, changes and fluctuations in interest rates can sometimes mean that one or the other has a significant advantage.
For example, when interest rates fall significantly, lower interest rates on ARMs can make it worth refinancing your mortgage.
Your home is now worth more
Another reason when it can make sense to refinance your mortgage is if your home has gone up in value. This is often a reason to refinance if you need to tap into your home’s equity. In the right circumstances, you can get a large amount of cash without increasing your mortgage term.
How does this type of cash-out refinancing work? Here’s an example.
Let’s say you took out a $200,000 mortgage to buy a home worth $250,000. You paid $50,000 for the down payment, and now, after many years, you have $100,000 left to pay on the mortgage. That means you have $150,000 in home equity. You can tap into your home equity by refinancing your mortgage for, say, $120,000. You can then use the difference in cash ($20,000) to pay for home improvements, get rid of bad debt, or make a major purchase.
In these circumstances, it is crucial to use the borrowed money wisely. You should also make sure that the cost of refinancing your mortgage to pay off debt is justified. In some cases, having a solid plan to pay off debt can be cheaper than refinancing.
Refinance to get rid of Private Mortgage Insurance (PMI)
Most of the time, if you pay less than 20% for your home as a down payment, your lender will require PMI. This is an added cost to your monthly payments until you build up enough equity to have it removed. If your home is worth more today than the sale price you paid for it, you may be able to refinance by borrowing the same amount you currently owe. This would decrease your loan-to-value ratio (LTV) simply because your home has gone up in value.
For example, let’s say you still owe $170,000 on a mortgage for a $200,000 house you bought 5 years ago (85% LTV). But now, the house is worth $215,000. So if you take out a “new” mortgage by refinancing (still borrowing $170,000), your LTV would fall to 79%. That means you would have 21% equity in your home, and can get rid of PMI.
You’ve got a better credit score
If your credit score has significantly improved since you got the mortgage, then refinancing could be smart. With better credit, you may qualify for a lower interest rate. Over the term of the mortgage, this could save you a lot of money in interest.