A mortgage refinance pays your existing loan and replaces it with a new one. As a homeowner, you can refinance your mortgage to save costs or to get better repayment terms. You can use your current lender or a new one to refinance your mortgage. But you must note that the new loan still comes with closing costs and other fees that can amount to 3-6% of the loan value.
So, when is it a wise idea to refinance a mortgage? You need to determine whether refinancing your mortgage is a wise financial decision.
Refinancing to get a lower interest
Refinancing your mortgage can save you more costs if you get a lower interest by at least 2% than your original mortgage. With the current pandemic hit economy, you might score lower interest rates, especially if your initial mortgage was locked at a higher percentage point.
If you get lower interests from private lenders, it is a good idea to refinance your mortgage, which is possible if you have improved your creditworthiness. Reducing your mortgage interest saves money, may reduce your monthly payment, and increases the rate at which you build your home equity. But ensure the savings outweigh the upfront costs.
Refinancing to change the loan term
Another reason why refinancing a mortgage might be a good idea is when you want to change the loan term, that is, extend or shorten it. An alternative mortgage to shorten your loan term is a good idea. Although it increases your monthly payment, it gives you more savings on interest in the long run since you pay off your loan in a shorter period. You also get to build equity in your home faster.
If you find it hard to afford your monthly mortgage payment, you can refinance to extend the loan term. Although you reduce your monthly payments, you end up paying more in the long run.
Converting an ARM to a fixed-rate loan
With a fixed-rate mortgage, you agree on an interest rate at the start of the loan and maintain it that way. On the other hand, with an adjustable-rate mortgage (ARM), your loan interest is fixed for a certain period and then adjusts depending on the market rates at predetermined time levels.
Moving to a fixed-rate loan gives you a lower interest rate and eliminates concerns over unexpected hikes in future interest rates. Converting a fixed-rate loan to an ARM that usually has a lower monthly payment is a better strategy for falling interest rates. So refinancing a mortgage can let you change your mortgage type depending on your financial situation.
Consolidate debt or tap equity
You can benefit from your home equity with a cash-out refinance to get cash upfront. A cash-out refinance means taking a larger loan than your current one, paying off your existing loan and getting the money left over in cash. However, refinancing your mortgage this way increases your monthly payment and interest rate since the lender takes a bigger risk. It might be a smart idea if you want to finance home improvement or consolidate debt.
The bottom line
Your reason to refinance a mortgage should be to reduce debt, save money, build equity and eliminate your mortgage payment quickly.