A home mortgage is likely the largest loan you will ever take out, and many people spend 30 years of their lives paying it back. Homeowners are often determined to get their mortgage cleared so that they can eliminate monthly payments and achieve true financial freedom. In some cases, refinancing a mortgage can help.
One of the major reasons that people look to refinance their mortgage is to obtain a better interest rate, leaving them free to build equity in the home much more quickly. However, to answer the question “When does it make sense to refinance a mortgage?” a lower interest rate is not the only factor to consider.
This article explains why refinancing might work for you, as well as how to refinance your home to your best advantage.
Reasons for Refinancing
When you refinance, your current mortgage loan will be paid off with a new mortgage loan. There are many reasons why people may decide to refinance their home. One of the main reasons is to cash out on existing equity. Homeowners can do this with a certain type of refinance loan called a cash-out refinance loan.
Aside from being able to cash out, you might consider refinancing your home for a variety of other reasons, including:
- Getting a better rate of interest.
- Reducing your required monthly payment amount.
- Changing the type of mortgage you have (for example, going from an adjustable-rate mortgage to a fixed-rate mortgage).
- Change the duration of the loan (the number of years you have to pay it back).
When Should I Refinance?
Knowing when to refinance your home can make your decision a lot simpler. Here are some situations where refinancing is a good choice.
- If your current mortgage deal is coming to an end, refinancing can provide you with the opportunity to take advantage of a new incentive like a better interest rate. In most cases, when your offer period ends, the lender will automatically transfer you to a variable rate, which could see your interest rates go up. A few months before the end of the offer is a good time to start looking at refinancing options.
- Cashing out is one of the biggest reasons for refinancing. If you need a new car or home improvements and cannot get a good loan, a cash-out refinance may be the solution.
- Converting to an adjustable rate or fixed rate is a common reason for refinancing. If your adjustable-rate mortgage goes up, a fixed-rate loan can mean a lower payment and less interest. If interest rates are falling, you may consider refinancing from a fixed-rate to an adjustable-rate.
What to Consider Before Refinancing Your Home
Before deciding to refinance your home, it is important to think about how refinancing will be beneficial to you and your financial situation.
What Will You Gain From Refinancing?
The best refinancing options will give you a better interest rate, as well as lower monthly repayments. While this is a tempting prospect, it pays to look at what you will gain.
If your 30-year mortgage has 25 years remaining and you refinance for a further 30 years on a mortgage with a lower interest rate, you will get that lower monthly repayment. However, because you will have now borrowed money over 35 years as opposed to the original 30, you may end up paying more in interest, making this less than beneficial.
That being said, with 25 years left, a 15-year mortgage could save you a lot of money in interest, even if your monthly payments end up being slightly higher. Additionally, your mortgage debt will be cleared much more quickly.
When asking yourself “Should I refinance my house?” you should be prepared to do the math to work out what you will gain before making any other decisions.
Additionally, many mortgage experts will tell you that unless you can obtain a new interest rate that is more than 1 percent lower than your current one, refinancing may not be worth the hassle.
Will You Be Approved?
As with any type of loan, a mortgage refinance depends on your eligibility. A lender will look at your income as well as your credit score and how much equity you have already built-up in the house. If you do not meet the criteria for the loan, you will be unable to refinance.
Even if you have never missed a payment, a low credit score or not enough equity can be the difference between being approved or denied. Going through the process will impact your credit score, so if you are not confident that you will be approved, it might not be worth applying.
Are You Planning to Stay in the Property?
As a rule of thumb, refinancing your home should only be done if you intend to remain in the property for a decent period of time. The reason for this is that when you refinance, you will be faced with a variety of fees and costs. While these are, for the most part, unavoidable, they are relatively easy to recover over the years as you continue making payments. However, if you plan to sell your home, there is little chance of breaking even, leaving you in a less than desirable position.
The best way to determine how long it will take to break even is by discussing your situation with a mortgage advisor who will be able to work this out and give you a clearer idea of whether refinancing is a suitable option.
How to Refinance Your Home
If you have made the decision that refinancing is the best choice for you, it is worth keeping these handy tips in mind:
- Take advantage of a mortgage refinance calculator, as this will provide you with the best deals to help you shop for a new mortgage.
- Be clear about your refinancing goals and make sure to select an option that will best help you achieve these.
- If you can, go for a fixed interest rate to avoid paying more in the future.
- Do not be afraid to apply for more than one loan at the same time. Not only will this have the least impact on your credit score, but it will also give you the freedom to look over each contract and make the best choice for your needs.