When you bought your home, you may not have ever planned to talk to a mortgage professional again. But you may reconsider: mortgage rates have fallen again. Here’s what to know about refinancing your mortgage.
What is mortgage refinancing?
Simply put, refinancing a mortgage means you get a new loan to replace your current home loan. If interest rates have dropped substantially since you signed your mortgage, you may be able to save a lot of money by refinancing to a new loan with a lower interest rate. It’s worth considering a refinance if you can lower your interest rate by about 1 percentage point or more.
If you’ve been making regular payments on your mortgage for several years, you’ve likely build up some amount of home equity. Refinancing can be a way for you to take out some cash against that home equity, to fund home improvements or for any other purpose.
When should you refinance your mortgage?
Homeowners refinance their home loan for a variety of reasons:
- To get a lower interest rate. This usually means a lower monthly payment.
- To get a shorter term, so the mortgage will be paid off sooner. Example: replacing a 30-year mortgage with a 15-year loan.
- To get a lower interest rate and a shorter term.
- To switch from an adjustable-rate mortgage to a fixed-rate loan.
- To extract cash from the home’s equity. This is known as a cash-out refinance.
Benefits of refinancing your mortgage
Refinancing your mortgage can improve your finances by:
- Freeing up money each month. If your refinanced mortgage has a lower monthly payment, you can put the saved funds toward other purposes, such as paying bills, paying down debt, funding your retirement, or even applying the extra money back to the loan to pay down the principal faster, with less interest.
- Pay off your house sooner. Refinancing from a conventional 30-year mortgage to a 15- or 20-year mortgage could help you become debt-free before retirement.
- Tap home equity to pay for renovation projects. If value of your home rises over time, you can access the home equity through a cash-out refi.
Risks and costs of refinancing a mortgage
Refinancing may be a mistake if you aren’t able to lower your interest rate much, or you incur a lot of fees.
- Refinancing isn’t free. Your refinanced mortgage comes with origination fees, an appraisal, title insurance, taxes and other costs, just like your original mortgage did. Even if the refi results in a lower monthly payment, you won’t actually save money until the monthly savings offsets the cost of refinancing. You’ll need to do some math to figure out how many months it will take to reach this break-even point, which will help you decide whether it’s worthwhile. To do this, divide the cost of the loan by the monthly savings. The resulting number is the amount of months it will take you to break even on your refi.
- You may have a prepayment penalty. Ask your lender whether your original mortgage agreement includes any charges for paying off the loan early.
- Your total financing costs can increase. If you refinance to a new 30-year mortgage, you’re likely going to pay more interest and fees than if you’d kept the original mortgage.
No cash-out refinance vs. cash-out refinance: What’s the difference?
When you refinance in order to reset your interest rate or term, or to switch, say, from an ARM to a fixed-rate mortgage, that’s called a ‘no cash-out refinancing,’ or a ‘rate-and-term refinancing.’ For example, if you have an ARM that is set to adjust upward soon, and you refinance into a fixed-rate mortgage.
Rate-and-term refinancing pays off one loan with the proceeds from the new loan, using the same home as collateral. This type of loan allows you to take advantage of lower rates or to shorten the term of your mortgage in order to build equity faster.
On the other hand, cash-out refinancing leaves you with cash above the amount needed to pay off your existing mortgage, closing costs, points and any mortgage liens. You may use the cash for any purpose. Keep in mind, in order to be eligible for cash-out refinancing, you must have sufficient equity.
It’s best to approach refinancing with a goal in mind, whether it’s saving money every month, paying off your loan earlier, or using the cash from your equity. From there, we’ll help you make it happen! Contact us today.