When Should I Refinance My Mortgage?
Author:
Victoria ArajMar 20, 2024
•8-minute read
Your mortgage is one of the biggest and most important investments you’ll make in your entire life – and it can also help you reach your financial goals. A mortgage refinance can be a wonderful tool to help you reach those goals even sooner. This is a transaction in which you’ll receive a new mortgage to pay off your old mortgage.
But should you refinance your mortgage? When is it the right choice? You can make that decision confidently after understanding the circumstances that call for a refinance.
Why Should I Refinance My Mortgage?
Refinancing can allow you to change the conditions of your mortgage to secure a lower monthly payment, get a new loan repayment term, consolidate debt or even take some cash from your home’s equity to put toward bills or renovations.
Here are some common uses of a mortgage refinance and how it might benefit your needs or financial goals.
1. You Want To Secure A Lower Interest Rate
If rates were particularly high when you took out your original mortgage and they’ve since dropped significantly, you’ll likely be able to refinance to a lower rate. This has the potential to lower your mortgage payment.
Remember that closing costs (if rolled into your refinanced loan), property taxes and insurance could all affect how much you’ll save each month – or if you save any money at all. Closing costs alone can incur up to 6% of the loan amount along with common fees including the origination fee, attorney fee, credit check fee and application fee among others.
Without factoring in taxes and insurance, let’s take a look at how a mortgage rate that’s 1% lower could impact your monthly payment.
Loan Amount | Interest Rate | Mortgage Term | Monthly Payment | |
---|---|---|---|---|
Loan #1 | $250,000 | 6% | 30-year fixed-rate mortgage | $1,499 |
Loan #2 | $250,000 | 5% | 30-year fixed-rate mortgage | $1,342 |
Based on this data you could save $157 a month by reducing your rate 1%. Consider these savings over 30 years and you could save $56,520 in interest.
2. You Need To Change Your Loan Repayment Term
A refinance can allow you to lengthen the term of your mortgage and lower your monthly payments. For example, you can refinance a 15-year mortgage to a 30-year loan to lengthen the loan term and make a lower payment each month.
When you lengthen your mortgage term, you may get a slightly higher mortgage interest rate. Lenders take inflation into account, and a longer mortgage term means you’ll likely pay more in interest over time.
You can also refinance your mortgage in the opposite direction, from a longer-term to a shorter-term mortgage. When you make this switch, you’ll likely have lower interest rates and own 100% of your home sooner. However, this will also make your monthly payments increase.
3. You Need Cash To Pay Off Debts
It’s possible to build home equity in two ways: paying down your loan’s principal balance and the home experiencing an increase in value. Typically, if your loan is more than 5 years old, you’ve probably built a bit of equity in your investment just by making your regularly scheduled monthly payments.
A cash-out refinance allows you to take advantage of the equity you have in your home by replacing your current loan with a higher-value loan and taking out a portion of the equity you have. If you have higher-interest debts spread over multiple accounts, you can also use a cash-out refinance to consolidate your debts to a lower interest rate, pay off each account and transition to one monthly payment.
4. You Want To Make Home Improvements Or Renovate
From fixing a broken HVAC system to replacing the pink linoleum in the bathroom, you might need to refinance to invest in home improvements at some point or another.
Using home equity can be better than taking out a personal loan or putting charges on a credit card because cash-out refinances usually have a lower interest rate than both.
5. You Want To Convert An ARM To A Fixed-Rate Mortgage
An adjustable-rate mortgage (ARM) generally offers borrowers a lower interest rate at the beginning of the loan. But after a fixed period (usually 5, 7 or 10 years), the interest rate has the potential to fluctuate – and not always in the borrower’s favor. For this reason, some homeowners will opt to refinance their ARM to a fixed-rate mortgage, which eliminates this fluctuation in interest rate.
It’s also possible to refinance a fixed-rate mortgage to an ARM. This involves some risk, but it could be a smart option if interest rates are falling. Or it may be wise if you plan to sell your home before the initial period of fixed (generally lower) interest ends.