What does it mean to refinance a mortgage? It’s actually more simple (and less scary) than you might think. A refinance, or refi as the financial experts say, is replacing your current mortgage with a new mortgage. If the conditions are right, refinancing can help you save money and/or reduce your debt quicker. Today, we are reviewing four reasons a homeowner may opt to refinance a mortgage.
Lower Your Interest Rate
The most common reason that people choose to refinance a mortgage is because they can obtain a lower interest rate. How much lower do rates need to be to make it worth it? Well, that depends on multiple factors and who you ask. Opinions vary among financial experts–some say you should refinance with only a .5% change in interest rate, while others say it’s not worth it if the reduction is less than 2%.
Refinancing at a lower rate will reduce your monthly payment. But, you must also consider how refinancing will impact other factors such as the term of your loan and the closing costs involved with refinancing. An experienced loan officer can help you work through calculations.
Shorten Your Loan Term
In some cases, lowering your interest rate can allow you to shorten the term of your new, refinanced mortgage. As an example, you could move your 30-year term loan down to a 15-year term. Your monthly payment could go up a bit, but you’d be mortgage free in a shorter time frame and save money in the long term.
Switch Between Adjustable Rate and Fixed Rate Mortgages
When you initially take out a mortgage, you have two basic rate options:
- Adjustable Rate Mortgage (ARM): These rates often start low and adjust (increase or decrease) with market conditions.
- Fixed Rate Mortgage: Lenders lock in a single interest rate for the entire life, or term, of the loan.
As you can imagine, there are trade-offs to choosing either option. Home buyers may refinance to switch from an ARM to a fixed rate, which can help them save money if interest rates are anticipated to rise. Conversely, they can opt to move to an ARM over a fixed, which may be a good idea if interest rates are expected to go down.
Accessing Equity or Consolidating Debt
The fourth and final reason on our list is to access equity or consolidate debt. Equity is calculated by taking the current market value of your home and subtracting the amount still owed on the mortgage. Once you establish equity in your property, you can borrow against it by refinancing. People typically do this to finance home improvements, college costs, business investments, and other large purchases.
Homeowners can also tap into their equity to consolidate debts. By refinancing a home mortgage, they can use the equity loan to pay-off existing debt and manage repayment through a single mortgage payment, usually at a lower interest rate. It’s important to know yourself and your spending habits before refinancing to pay off other debts and seek expert advice before using up some or all of your equity.