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Should I Refinance My Mortgage And When?

Andrew Dehan8-minute read

July 15, 2022

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Your mortgage may be one of the biggest and most important investments you make in your entire life – and it can also help you reach your future financial goals. A mortgage refinance can be a wonderful tool to help you reach those goals sooner.

But is it the right choice? Here’s a reference guide to help you decide if a refinance of your current mortgage is right for you.

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What Is A Mortgage Refinance?

A mortgage refinance is simply a transaction where you get a new mortgage to pay off your old mortgage. As a homeowner, you’ll have the opportunity to choose among all the types of mortgages available to home buyers. Understanding your options will help you choose the best loan for buying your house for a second time.

Why Should I Refinance My Mortgage?

Refinancing can allow you to change the terms of your mortgage to secure a lower monthly payment, switch your loan terms, consolidate debt or even take some cash from your home’s equity to put toward bills or renovations.

Let’s take a deeper look at some of the reasons you may want to refinance.

You Need To Change Your Loan Term

There are several reasons homeowners might want or need to change their loan term. Here’s a bit more information on switching to a longer or shorter term.

Longer Mortgage Term

Are you having trouble making monthly mortgage payments? 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 term of your loan and make a lower payment each month.

When you lengthen your mortgage term, you may get a slightly higher interest rate because lenders take inflation into account, and a longer mortgage term means you will likely pay more in interest over time. If you know your current payment schedule isn’t realistic for your household income, a refinance can free up more cash so you can invest, build an emergency fund or spend it on other necessities.

Shorter Mortgage Term

You can also refinance your mortgage in the opposite direction, from a longer term to a shorter term mortgage. When you switch from a longer-term mortgage to a shorter one, you will likely enjoy lower interest rates and you’ll also own your home sooner.

Usually (but not always), switching to a shorter term also means that your monthly payments will increase, so make sure you have enough stable income to cover your new payments before you sign on for a shorter term.

You Need Cash To Pay Off Debts

If you’ve made payments on your mortgage, you probably have equity in your home. Equity is the difference between your home’s fair market value and the amount you still owe to your lender. There are two ways to gain equity: You pay off your loan principal, or your home’s value rises. As a rule of thumb, 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.

Cash-Out Refinance For Debt

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.

For example, let’s say you have a $200,000 mortgage and $50,000 worth of equity - this means that you still owe $150,000 on the loan. You might accept a new loan for $170,000, and your lender would give you the $20,000 difference in cash a few days after closing.

You might seek a cash-out refinance because you need money to pay off other debt. If you have debts spread over multiple accounts, you can use a cash-out refinance to consolidate your debts to a lower interest rate, pay off each account and transition to one monthly payment. Consolidation can help you keep a better record of what you owe and reduce instances of missed payments, late fees and overdraft charges.

You Want To Do Home Improvements Or Renovations

From fixing a broken HVAC system to replacing the pink linoleum in the bathroom, you might need to invest in your home at some point or another. Using the equity in your home can be better than taking out a personal loan or putting charges on a credit card because cash-out refinances usually have lower interest rates than most credit cards.

Cash-Out Refinance For Renovations

The average 30-year mortgage rate is currently under 4%, and the average low-interest credit card rate is more than 12%. If you choose a variable rate credit card or a store credit card, you’ll likely pay even more in interest. If you have enough equity in your home to do a cash-out refinance, you can complete your renovations or repairs without excessive interest charges.

Though you can do anything you want with the money you get from a cash-out refinance, it’s important to remember that your refinance is still a loan. It’s a good idea to get estimates from contractors or repair professionals before you close on your refinance. This will lessen the chance that you take out too much money, or you take out too little and have another bill after the job is finished.

You Want To Allocate More To Retirement Saving

One of the most powerful tools that you can take advantage of when it comes to saving for retirement is the principle of compounding interest. The earlier you start to invest and save, the more years you have to accumulate interest on your investments before you retire.

Cash-Out Refinance For Investing

If you have equity sitting in your home but you haven’t maxed out your annual retirement contribution limits, you may end up making more money over time by taking a cash-out refinance and investing the difference.

You can also use the money from a cash-out refinance to invest in your property. Whether you want to add a new bathroom, spruce up your paint or install a privacy fence, you’re only limited by your imagination. Upgrades can bring in more money when you want to sell your house by increasing your home’s value and curb appeal, both of which can help you secure a higher final closing price.

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 into a fixed-rate mortgage, which eliminates this fluctuation in interest rate.

It’s also possible to refinance a fixed-rate mortgage into an ARM. This involves some risk, but it could be a smart option if interest rates are falling, or if you plan to sell your home before the initial period of fixed (generally lower) interest ends.

How Do I Decide If I Should Refinance?

It’s important to take a holistic approach in determining if a mortgage refinance is a good option for you.

Assess Your Finances

First, you’ll want to look at your current financial situation and assess your long- and short-term financial goals and how much it’ll cost to refinance your mortgage.

Understand Mortgage Refinancing

Next, take the time to thoroughly understand what a mortgage refinance is and how it works. This will help ensure there are no surprises along the way.

There are pros and cons to refinancing. A drawback of refinancing is that it incurs closing costs. You’ll want to make sure you take expenses and other potential downsides into account when deciding whether a refi is right for you, particularly if you’re planning to sell in the near future.

Use A Mortgage Refinance Calculator

To get a basic idea of how a refinance could affect your monthly mortgage payment, it’s best to use a refinance calculator. Simply input some basic information about your goals, current mortgage, where you’re located and your credit score, and you’ll instantly be able to calculate what your refinance payment could look like.

Consider Timing

Timing is another huge consideration. Some time frames are better than others when it comes to refinancing, so it’s crucial to understand when it makes the most sense, practically speaking.

When Should I Refinance?

Think you’re ready to refinance? Make sure you meet the requirements to refinance first – and don’t forget to consider home values and interest rates in your area, how long it can take to refinance and how often you can refinance.

When Your Credit Score Increases

Waiting for interest rates to drop isn’t the only way you can qualify for a lower rate. You may also qualify if your credit score is now higher than it was when you applied for a loan.

The Importance Of Your Credit Score

Why do mortgage lenders care about your credit score? Your credit score is a numerical representation of how well you manage debt. If your score is high, it’s probably because you always make your loan payments on schedule and you don’t borrow too much money. On the other hand, if your score is low, it’s likely because you have trouble managing debt.

A mortgage is a form of debt. Lenders look at your credit score before they offer you an interest rate because they need to know how reliable you are as a borrower. If you have a higher score, you’re statistically less likely to miss a payment or fall into foreclosure. This means that your lender takes less of a risk when they loan you money and can give you a lower interest rate. If your score is low, it means there’s a higher chance that you might not pay back what you borrow. Your lender needs to manage the risk they accept by giving you a higher interest rate on your loan.

The good news is that making your mortgage payments on time each month increases your credit score. If you haven’t checked up on your score in a while, you might be in for a pleasant surprise. Look at your numbers and compare them to your score when you got your loan. If they’re much higher than they were when you applied, you might want to seek a refinance.

When Interest Rates Are Low

One of the best times to reevaluate your mortgage is when interest rates on home loans significantly drop. Your interest rate plays a large role in the amount of money that you end up paying for your home. If you’d locked into a loan during a time when rates were high, you might be overpaying for your mortgage. You can save money by refinancing to a loan with a lower rate.

The Impact Of Interest Rates

Just a few tenths of a percentage point difference in interest rates can mean a huge amount of money saved by the time you own your home. Let’s look at an example. Imagine that you have a mortgage with $150,000 left on your principal balance. You have a fixed rate of 4.5% and 15 years left on your term. Now, imagine you see that mortgage rates are lower now than what you’re paying. A lender offers to refinance your loan with the exact same terms to a 4% interest rate.

If you keep your current loan, you’ll end up paying $56,548.21 in interest by the time you finish paying off your loan. If you take the refinance, you pay $49,715.71 in interest before you own your home. Just half a percentage point difference saves you over $6,000.

The Bottom Line: Refinancing Your Mortgage Can Put Money In Your Pocket

Everyone’s situation is different, but there are many financial questions that a refinance can answer. Right now, those considering a refinance should know that interest rates are still at near-historic lows. Don’t delay – take advantage of these rates while they last.

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Andrew Dehan

Andrew Dehan is a professional writer who writes about real estate and homeownership. He is also a published poet, musician and nature-lover. He lives in metro Detroit with his wife, daughter and dogs.