There are several reasons why refinancing your home could be a smart financial move. This guide dives into how refinancing works and the most common reasons why homeowners refinance. You’ll also learn about a reputable lender that can assist you when you’re ready to move forward with refinancing your mortgage.
How Refinancing Works
Refinancing involves swapping out your current loan for a new one. First, you’ll apply for a new loan with the lender, and if you’re approved, they’ll pay off your existing mortgage. Then, once the transaction closes and the new loan is funded, you’ll start making payments to the new lender.
Is Refinancing a Home Worth It?
It depends on your goals and if the numbers make sense. Ideally, refinancing should result in sizable cost savings or a more affordable mortgage payment. Or you can refinance to pay your home loan off faster or convert a portion of your equity into cash to make a large purchase, cover the cost of home repairs or improvements, or consolidate high-interest credit card debt. But before you start the process, review this guide to discover common reasons that warrant refinancing.
7 Common Reasons Why People Typically Refinance Their Homes
Here’s a breakdown of the most common reasons why many homeowners refinance their mortgages.
1. Getting Lower Interest Rates
If your credit score has improved since you took out your home loan, you could qualify for a better mortgage rate. This is also the case if average interest rates on home loans are lower than they were when you locked in your rate for your current home loan. Either way, refinancing to secure a lower rate means you’ll likely get a more affordable monthly payment. Furthermore, you could save several thousands of dollars over the loan term, depending on how much you owe when you apply for refinancing.
To illustrate, a $250,000 30-year fixed-rate mortgage with an interest rate of 6 percent comes with a monthly payment of $1,498 (principal and interest only). But if you can get a rate of 4.5 percent, your monthly payment will drop to $1,266.
2. Shortening Loan Terms
Some homeowners also refinance to pay their loans off faster. And if interest rates have fallen, you could cut your loan term in half without seeing much of a difference in your monthly payment.
Using the example above, assume you refinance after a year to secure an interest rate of 3 percent. If you opt for a 20-year mortgage term to reach the finish line faster, your new monthly payment will be $1,386. That’s a decrease of $112 per month, you’ll shave nine years off the loan term, and you’ll save several thousand in interest.
But if you opt for a 15-year loan with a 3 percent interest rate, your mortgage payment will be slightly higher at $1,726. However, the interest savings will be even greater if you refinance since you’ll be cutting the initial loan term in half.
3. Converting Mortgage Loans
Do you have an adjustable-rate mortgage that you’d like to convert to a fixed-rate mortgage to get a more predictable monthly payment? Or maybe you’re planning to move soon and would prefer an ARM over a fixed-rate loan to lower your monthly payment. Either way, you can refinance to change your loan type.
4. Getting Rid of Private Mortgage Insurance (PMIs)
You’ll also find that homeowners with FHA loans often refinance into conventional loans to get rid of mortgage insurance. FHA loans require you to pay mortgage insurance for the duration of the loan. But if you have a conventional loan, you can get rid of it when you reach 20 percent in equity.
5. Consolidating High-interest Debts
Cash-out refinances, which allow you to convert a portion of your equity into cash, are often used to consolidate high-interest debt. The interest savings could be sizable, depending on the interest rates. Still, you have to be disciplined enough not to get back into debt for a cash-out refinance to make sense. It’s also important to understand that the amount you pull out will be added to your outstanding balance, and you’ll get a new loan with different terms, which will likely come with a higher monthly payment.
6. Financing Home Renovations and Repairs
Is your home in need of costly repairs? Or maybe you want to complete renovations to make it more functional. You can also use a cash-out refinance to cover the costs. If the repairs or upgrades will increase the value of your home, refinancing could be a smart financial move. Not only can you command a higher sales price if you decide to sell your home in the near future, but you may also be able to pull out more equity from your home later on down the line.
7. Buying Investment Properties
You’ll often need to make a larger down payment to buy investment properties. However, if you don’t have the cash on hand, you can also tap into your equity through a cash-out refinance to come up with the funds you need to secure the income-producing properties.
