Refinancing is the process of getting a new mortgage with better terms and conditions to replace your existing mortgage. If mortgage rates have fallen drastically, refinancing can be a huge money saver, resulting in lower monthly mortgage payments and total interest savings. If you have ever considered refinancing, you should know exactly when it will be to your advantage to do so.
Lower Interest Rate
One of the biggest reasons to refinance is to try to lower your mortgage rate. A lower mortgage can help you get monthly savings, which can be reinvested or saved. For example, if you refinance your mortgage on your $500,000 home in 10 years from a rate of 4% to 2%, your monthly mortgage payment can be reduced by $900! You can use Casaplorer’s mortgage refinance calculator to see how much you can save.
Due to the coronavirus pandemic, the FED reduced interest rates, which had a domino effect and eventually reduced mortgage rates. Therefore, if you were locked into a mortgage rate from years ago, the lower rate today can save you.
Change Loan Term
Refinancing can be a great opportunity to change your loan term. If you are locked into a 30-year mortgage and, after the fifth year, have saved enough to realize you can manage a 15-year mortgage, you can refinance and change the term. This will result in a higher monthly payment. You will also save on the total interest you will pay over the life of the loan.
It can work the other way, too. If you initially signed up for a 15-year mortgage and the monthly payment is too high, you can refinance it into a 30-year term and have more manageable monthly payments.
Cash-Out Refinance
Cashing out when you refinance allows you to borrow additional funds over what is owed on your existing mortgage. These funds can be used for home renovations, investments, other expenses, etc. Cash-out can be a good method to borrow funds if you plan to refinance. The funds are borrowed at a low rate and can be used to pay debt with higher interest rates, like credit cards.
The biggest advantage of a cash-out refinance is there are no separate debt repayments. This results in a higher monthly payment than what it could have been if you had not taken the cash-out option. The disadvantage is the home is the collateral. If you overextend yourself, it could put your residence in jeopardy.
Adjustable-Rate to Fixed-rate
Adjustable-rate mortgages (ARM) change with a benchmark index like the prime rate and a credit spread. This results in unpredictable mortgage payments. If you have an ARM and dislike the unpredictability, you can choose to refinance your mortgage into a fixed-rate mortgage. Fixed-rate mortgages have the same monthly payment for the term of the loan.
Remove FHA Mortgage Insurance Premium (MIP)
FHA loans require all borrowers to get an FHA mortgage insurance premium (MIP). This can last for the life of the loan or 11 years, depending on your down payment. If you have a down payment of less than 10% you have to pay insurance for the entire mortgage even 30 years! You cannot remove FHA MIP even when you reach 20% equity in the home. The only way to remove FHA MIP is to refinance your FHA loan into a conventional loan. Once it is a conventional loan, insurance can be removed when you have 20% equity ownership.
Now that the reasons to consider getting a refinance are covered, you should also know about the costs of refinancing a mortgage. Mortgage refinancing is not free. It can result in closing costs ranging from 3% to 5% of the loan amount. A mortgage refinance with a loan of $400,000 can result in $12,000 to $20,000 in refinance closing costs. These charges can include a host of fees from applications, inspections, lawyers, origination charges, etc.
In conclusion, mortgage refinancing can benefit most home borrowers if the refinance results in overall savings. However, not everyone should refinance. If you have poor credit, haven’t built enough home equity, and do not have savings for closing costs, you should consider waiting instead of refinancing. In each case, you should always look at your financial goals from a short-term liquidity perspective and long-term savings perspective to maximize the benefit of any financial decision!