When it comes to refinancing your mortgage, you can think of the process as a debt redo. Essentially, you’ll swap out your existing loan for a new one - ideally with better terms and conditions.
There are several reasons to consider refinancing your mortgage – to take advantage of lower interest rates, tap into your built-up equity, decrease your monthly payments, convert the loan type, or change the loan term.
While the benefits are clear, the process of refinancing and how it all works can still be quite confusing. Here’s a breakdown.
What is Refinancing?
A refinance is the replacement of current debt with a new loan. This new loan will pay off the existing debt and establish a new agreement.
You can refinance any kind of debt, including student loans, auto loans, small business loans, and of course, a mortgage. This may lower your interest rate and in turn, decrease your monthly payment.
How Does Refinancing Work?
Similar to when you initially purchase a home and secure a mortgage, when refinancing, you must first secure funding from a qualified lender. The terms and conditions will again depend on a variety of personal factors, including your creditworthiness, financial health, and inherent risk.
Some of the common qualifications needed to refinance are:
- Sufficient payment history on the existing mortgage
- Verification of income and employment
- Low debt-to-income ratio
Reasons To Refinance Your Home Mortgage
Because a mortgage is typically the largest amount of debt an individual has outstanding, refinancing a mortgage can vastly change your monthly expenses and savings. Here are some reasons a refinance may make sense for you financially.
Lower Mortgage Rates
A decrease in mortgage rates is the usual trigger that leads to a refinance (a lower interest rate typically leads to lower monthly payments for the borrower). If your new mortgage rate is lower than your current rate by 1% or even 1/2%, it may make sense to refinance.
There are multiple reasons that your mortgage rate could decrease -- standard market rates could have declined or your personal creditworthiness, measured by your credit score or income profile, could have improved since you originally obtained your mortgage.
Change Loan Type
If you’re trying to transition from an adjustable-rate mortgage to a fixed-rate mortgage, a refinance could make sense. A fixed-rate mortgage has a guaranteed interest rate for the entire loan term, and will therefore reduce risk. An adjustable-rate mortgage, on the other hand, will have fluctuating rates.
While this change may increase monthly payments, your interest rate and monthly payments will remain constant for the entire life of your loan. Start by evaluating the current market rate on a fixed mortgage and calculate the possible savings on interest.
Many homeowners choose to refinance to get cash for the equity they have built in the home. This cash can be used for another investment, to make a home improvement, or for any other use a homeowner may have.
Lower Monthly Payments
Refinancing can be a helpful tool to save money on monthly bills, leaving you with more room to pay for other high-priority expenses. Extending your loan will typically lower your monthly payment.
While a longer-term will provide more flexibility to pay other bills, it may increase the amount of interest paid for the life of the loan.
Decrease Total Interest Paid
If your financial situation has materially changed since you initially purchased your home, you may want to decrease the term of your loan to more quickly build your equity. By decreasing the length of your mortgage, you may receive a lower rate from your lender and may pay less total interest during the time your loan is outstanding.
This option may increase your monthly payments, so it is best to make sure you have sufficient income to offset any higher monthly costs.
How Much Does It Cost to Refinance?
Closing costs vary and typically range from 2-5% of the current loan balance, which covers a variety of services and fees, similar to when you got your initial mortgage. Closing costs will also depend on:
- Size of the Loan
- Loan Term and Type
- Amount of Equity
It’s important to take the time to evaluate whether you can recoup the cost to refinance at the end of the loan term. If you don't intend to stay in the house long-term or you plan to refinance again in the future, you’re not guaranteed to break even in the end. You will want to ensure the benefits of the new loan outweigh the cost.
Evaluating My Choice To Refinance My Mortgage
When deciding whether to refinance, it’s important to weigh the potential money saved against the amount it costs to refinance. However, at the end of the day, refinancing is worth it when it makes financial sense for you - both in the short-term and long term. It all depends on your financial goals.
Here are some scenarios when refinancing is worth it:
- If rates drop 1/2 a percentage point compared to what you’re currently at.
- If you need to increase the loan term for lower monthly payments.
- You can get the closing costs back within a few years. Set a cut-off timeline for recovering those paid fees. It could be 3 years, 5 years, etc. You have to make sure that the initial cost is worth it.
Here are some scenarios when refinancing is not worth it:
- You plan to move soon.
- Your current mortgage has a prepayment penalty.
If you are ready to start the refinancing process you can click here; if you have any questions and would like to discuss your current situation in more detail you can schedule a call with one of our experienced loan officers today.