Refinancing is the process of getting a new mortgage with better terms and conditions which replace your existing mortgage. Refinancing can be a huge money saver if the mortgage rates have fallen drastically, it can result 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 refinance your mortgage.
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 reduce 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 a couple of years ago, the lower rate today can save you a lot of money.
Change Loan Term
Refinancing can be a great opportunity for you to change your loan term. If you are locked into a 30-year mortgage, and after the 5th year you have saved enough and realize you can manage a 15-year mortgage, you can refinance and change the term. This will result in a higher monthly payment, but you will save in the amount of 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.
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, and other expenses, etc. Cash-out can be a good method to borrow funds if you were planning on refinancing, 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 that there are no separate debt repayments, it results in a higher monthly payment as compared to what it could have been if you did not take the cash-out option. The disadvantage is that the home is the collateral and if you overextend yourself it could put your residence in jeopardy.
Adjustable-Rate to Fixed-rate
Adjustable-rate mortgages (ARM) changes with a benchmark index like the prime rate along with 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) which can last for the life of the loan or for 11 years depending on the amount of down payment that you made. 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 and can result in closing costs which can range from 3% to 5% of the loan amount. On a mortgage refinance with a loan amount of $400,000 this can result in $12,000 to $20,000 in refinance closing costs. These charges can include a host of fees from applications, inspections, lawyers, and origination charges, etc.
In conclusion, mortgage refinancing can be advantageous to 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 from any financial decision!