Refinancing your mortgage is a bold move, and in many cases, a financially empowering one. You need to know the whats, whens, whys, and hows of refinancing TO determine whether or not it’s the right move for you. Read on to find out if refinancing is in your future.
What Does Refinancing Your Mortgage Mean?
When you refinance your mortgage, you are taking out another mortgage loan on the existing home. Essentially, you’re reapplying for the loan, which usually means you’ll receive a new (ideally lower) interest rate and payment obligations.
If you’re fiscally conservative, you might heed the following advice. You should only refinance when you can:
- Lower your interest rate
- Shorten the loan period, OR
- Both of the above
While this is sound advice, there are other variables to consider before deciding to refinance your mortgage. Let’s take a look at them.
Refinancing Elements to Consider
There are a few factors to consider when you are determining whether it makes sense to refinance your mortgage.
Administration costs
Administration costs are fees involved with refinancing, similar to the fees incurred when you first bought the property. These include the origination fee, appraisal fee, title insurance fee, and credit report fee.
The costs usually vary between 3% and 6% of the total borrowed amount, so be sure to factor in these extra costs when considering refinancing.
The break-even period
You need to determine how many months it will take for the money you save from refinancing to break even with the closing costs.
Let’s say you’re refinancing to save on interest. In that case, you need to work out your monthly savings and determine how long it will take you to save as much on interest as you’ve spent on closing costs.
If the period is between 10-25 months, that’s reasonable. Approximately 50 months is fine but not ideal, and break-even periods of 75 months and over should not be considered.
The Right Reasons to Refinance Your Mortgage
As mentioned, refinancing can reduce your interest rate and/or make your loan term shorter. But you can also refinance to get some much-needed cash or lower your monthly repayments. Let’s explore some of the most common reasons for refinancing.
Lower Interest Rate
The most common and wisest reason for refinancing is the ability to capitalize on lower interest rates. Your bond is now recalculated at the new low-interest rate, and you can choose to reduce your term or your monthly payments or both.
Accessing Equity
Another widespread reason for refinancing is to access some cash. This is known as a cash-out refi, and it is possible if you have at least 20% equity remaining after the entire transaction.
If you need the cash for home improvements, education, or settling high-interest debt like credit cards, it’s a great idea. You won’t find a cheaper and more convenient way to access a large amount of cash.
Eliminating FHA Loans
Federal Housing Administration (FHA) loans include insurance premiums that can be pricey. While the loan might have been necessary initially, many people refinance when they’re financially stable, eliminating these extra insurance premiums.
Switching Rates
Another reason to refinance is to change your adjustable-rate mortgage to a fixed-rate or vice-versa. This decision should be based on the current interest rate and how long you plan to stay in the home.
Refinancing your mortgage can be a great decision as long as you consider all the variables. Take the time to evaluate all of the factors that could influence the impact of refinancing and make sure your reasons for taking this step match up with the potential outcomes.