With today’s interest rates still incredibly low, refinancing is still a common topic of discussion. Refinancing can be a great way to help save money, but it’s not a great option for everybody. It’s important to be aware of what exactly goes into a refinance so you can decide if it’s the right option for your situation.
Reducing Your Interest RateIn short, a refinance is when a borrower pays off their existing mortgage and replaces it with a brand new one. Refinancing has the potential to lower your interest rate, change the duration of your loan, convert an adjustable rate into a fixed rate, and let you access the equity in your home.
Refinancing does come with costs. Refinancing typically costs anywhere from 3% to 6% of the principal, requiring an appraisal, application fee, titles searches, etc. There are many different refinance programs out there (such as the FHA Streamline Refinance and the VA IRRRL) to help cater to everyone specific needs.
Reducing Your Interest RateSecuring a lowering interest rate is a primary reason to refinance. Experts typically say the if the interest rate can be reduced by at least 2%, then a refinance is usually a good idea. Not only will a reduced interest rate help save money, but it will also increase the rate at which the borrower builds equity in their home. It can also help reduce the size of their monthly payments.
Reducing the Loan DurationWhen interest rates fall, bowers will often have the opportunity to shorten the duration of their loan without having too much affect on their monthly payments. Be aware this can also greatly increase the size of a monthly payment. Reducing the duration of the loan is not always the best option.
Converting an ARM to a Fixed-Rate Mortgage and Vice VersaMany borrowers choose to get an ARM (Adjustable Rate Mortgage) because of low interest rates, but over time those rates can increase dramatically. Converting to a fixed-rate mortgage can lock in a low interest rate and prevent it from increasing over time. On the other hand, you can convert a fixed-rate mortgage into an ARM. Arms typically have lower monthly payments than fixed-rate mortgages and can be beneficial if interest rates are on a downward trend, especially if the borrower plans on selling the home soon.
Utilizing the Equity in Your Home or Consolidating DebtIt’s common for borrowers to tap into their home equity via a refinance to fund major expenses such as home renovations or college education. This can be beneficial if the renovations increase the value of the home, or if the interest rate from the refinance is lower than the interest rate of the college loan. Refinancing can also help consolidate one’s debt. If you can effectively replace your high-interest debt with a low-interest mortgage, then refinancing might be a beneficial option for you. As long as your spending habits are kept in check, this can be a useful option. In more severe situations, a cash-out refinance can be used to fun medical emergencies. This should only be done after careful consideration as this option is not beneficial for every situation.
Questions to Ask YourselfMaking the decision to refinance should not be taken lightly. Here are three questions you can ask yourself to help determine if refinancing is right for you.
- How long will I be in this home? If you only plan to stay in the home for a few years, refinancing might not be worth the time and cost.
- What are the details of my current mortgage? If you’re principal balance is low, gaining a low interest rate won’t be of much benefit since your payments will already be going toward paying down your principal.
- How is my current financial situation and credit? Refinancing does come with closing costs, so having enough cash on hand will be important. Additionally, most lenders will only allow borrowers to refinance if their credit score is in good standing.