Many homeowners believe that they’re locked into a mortgage for the long run, but
this doesn’t have to be the case. Refinancing your mortgage or borrowing a second mortgage at a lower interest
rate or different term, can offer sizable benefits to homeownership including providing a way to save money,
reduce debt obligations and build equity.
The Ins and Outs of Refinancing
While borrowers use the term “refinance” to refer to an adjustment of the amount,
duration or interest rate of a loan, it’s actually a bit of a misnomer. In reality, refinancing refers to taking
out a new, more desirable loan and using it to pay off the existing loan. Refinancing can be done at any time but
is most effective for those who have:
- Adequate equity in a home
- A strong credit score and credit history
- Appropriate income to cover the costs associated with
a new mortgage
Refinancing is largely circumstantial and not all homeowners are good candidates.
However, if homeowners have a compelling reason to seek out another mortgage loan and meet the general guidelines
to refinance, the advantages can be significant.
5 Benefits of Refinancing Your Mortgage
Refinancing is a compelling opportunity, particularly for homeowners looking to
save on expenses or increase their cash flow. Here are five benefits that come with a wise mortgage
refinance.
1. Reduce Your Interest Rate
When a loan’s interest rate is high, more of each payment goes toward interest
instead of principal — at least
during the initial mortgage years. This means more of your money is spent on the cost of the loan rather than
building equity in your home. Reducing your interest rate by refinancing your mortgage can make your monthly
mortgage payments to go further in the long run.
For example, if you take out a 30-year fixed-rate $200,000 mortgage at a 4.5
percent interest rate, you’ll be paying $165,000 in interest over the course of the loan. If you refinance at 3.5
percent interest, you will pay $123,000 in interest over the course of the loan, saving you $42,000 in interest.
While there’s no set-in-stone guideline for when to refinance, experts suggest you start shopping when there’s
a decrease of at least 1 percent in the going
interest rate.
2. Reduce Your Monthly Payment
If money is tight, your first priority may not be your principal; instead, you may
be more concerned about the amount you’re spending each month.
Refinancing your mortgage for a lower interest rate can cut down on your
obligations, freeing up your cash flow for other purposes. In the above example – a $200,000 mortgage at a 3.5
percent interest rate versus 4.5 percent over a 30-year term can reduce your monthly payment by about 12 percent.
For those with debt in other categories such as credit card debt or student loans,
lower monthly mortgage payments can free up enough cash so you can pay down debts that have a higher interest
rate.
3. Reduce Payment Terms
Thirty years is a long time to pay off anything – including a home. It’s not
uncommon for homeowners to take strides to either accelerate payments or cut the length of a mortgage as equity
increases. Refinancing can help with this, providing an easy way to shorten the duration of a loan.
While some homeowners do indeed refinance for the same loan terms, most borrowers
with enough equity in the home refinance for 15 or 20 years, even if the interest rate is the same. Carving
years off your loan will save you more money in the long run.
4. Reduce Total Payment
While a lower monthly payment is always a benefit, savvy homeowners know that the
total amount paid on a mortgage is equally important.
As demonstrated in the scenarios above, refinancing for a lower interest rate –
even just one percent lower- can reduce your total payment by thousands of dollars.
5. Put More Cash into Your Home
Unless you started from scratch, few homes are perfect as they are, and most home
purchases will require superficial upgrades at minimum. Sizable upgrades, like a new roof, HVAC system or kitchen
remodel, can exceed the average homeowner’s budget, creating a strong need for cash assistance.
Luckily, a refinance can help with this. A cash-out refinance is a way to turn your
home equity into cash, effectively borrowing against the equity in your home. This process entails borrowing more
than the remainder of your existing loan.
For example, if you owe $100,000 on your current home, refinancing for $120,000
will replace your existing mortgage loan and provide $20,000 of cash to use on home renovation projects. In
essence, you can refinance your loan at a more desirable rate such as a lower interest rate or shorter term while
also extracting cash you can use toincrease your property value.
Weighing the pros and cons of refinancing is highly situational, but with a little
guidance, you can be prepared to take the best possible steps forward, for both your wallet and your home.