Why Do You Refinance A House? 5 Reasons To Refinance Your Home Loan
Choosing to refinance your mortgage can be a helpful way to achieve your long-term financial and personal goals. If you’re a homeowner, you may reach a point where you decide to pursue a refi – but why should you refinance a home, and when is the best time to consider this?
Let’s explore the top reasons to refinance your home loan. Then, you can decide whether refinancing is the best option for your situation.
The 5 Best Reasons To Refinance Your Mortgage
When you refinance your home loan, you’re exchanging your current mortgage for a new one, typically with different loan terms. These new terms could help make your mortgage more manageable or save you money in the long run.
You might look at refinancing for a variety of reasons, but up next are the five most common reasons to refinance.
1. To Lower Your Mortgage Interest Rate
Borrowers may choose to refinance their mortgage to take advantage of low mortgage interest rates, especially if rates are lower than when the borrower initially took out the loan. Your interest rate impacts the size of your monthly mortgage payment and how much you’ll pay throughout your loan term. The higher your rate, the bigger your monthly payment will be and the more you’ll eventually shell out in interest.
So, refinancing to a lower interest rate can help decrease your monthly payment and save you money long term. Plus, it can help you build equity in your home at a faster rate. Your equity increases when you pay down the principal balance on your mortgage. If you’re paying more toward your principal every month (because you don’t have to pay as much in interest), you’re building your home equity more quickly.
2. To Change Your Loan Term
If interest rates are very low, borrowers may have the option to refinance to a mortgage with a shorter loan term without drastically changing the amount of their monthly payment. But even if this isn’t the case, you may still want to refinance to change the length of time you have to pay off your loan. Let’s see what happens when you shorten or lengthen your mortgage term.
Shorten The Loan Term
Refinancing to a mortgage with a shorter term (for instance, switching from a 30-year mortgage to a 15-year mortgage) can help you pay off your mortgage early, meaning you’ll own your house sooner and can free up funds for other financial goals. Paying back your loan over a shorter term can also help you save money on interest over the duration of the loan.
On the downside, switching to a shorter-term loan often increases your monthly payment amount. If you have trouble making your mortgage payments as is, shortening the loan term may not be the best option.
Lengthen The Loan Term
It’s possible that you want to refinance to a mortgage with a longer term and lower monthly mortgage payments. Lengthening your loan term reduces how much money you pay each month because you’re stretching out the amount of time you have to pay back the loan.
Your monthly payments will be lower on a mortgage with a longer term, but you’ll end up paying more in interest over time. Plus, it’ll take you longer to fully own your property.
However, if you’re experiencing a financial pinch around your payments, it’s often better to be proactive in revising your terms in order to avoid foreclosure. Keep in mind that refinancing to lower monthly payments can also free up funds to pay off other debts, build up your savings account or invest.
3. To Access Your Home Equity
Refinancing with a cash-out refinance allows you to use the equity you’ve built in your home. Your equity equals your home’s current worth minus how much you still owe your lender. A cash-out refinance replaces your current mortgage with a higher loan amount than you previously owed on the house, and you take a percentage of your home equity as cash to use for consolidating debt, paying for home improvements, college, retirement, a savings fund or making another investment of your choosing.
4. To Switch Mortgage Types
A refinance can also help you switch from one type of mortgage to another. When you bought your house, perhaps you took out an adjustable-rate mortgage (ARM). ARMs can be an appealing option to borrowers because they initially come with a relatively low interest rate and can save you money on your monthly payments in the short term.
The downside to this option is that your mortgage interest rate eventually goes up and it can fluctuate over time. This can lead to higher and more unpredictable mortgage payments at different times throughout the life of the ARM. With a refinance, you can switch from an ARM to a more predictable fixed-rate mortgage.
5. To Eliminate Mortgage Insurance
Do you pay private mortgage insurance (PMI) on your current loan? If you have a conventional mortgage, you’re required to pay PMI if you made a down payment of less than 20%. If you have an FHA loan, you’ll likely have to pay what’s known as a mortgage insurance premium, or MIP. You’ll typically pay a portion of the MIP when you close on the FHA loan, then make payments toward the annual MIP until your loan is paid in full.
With a conventional loan, you can ask your mortgage lender to cancel PMI once you have 20% equity in your home and the loan-to-value ratio (LTV) on your loan is 80% or less. With an FHA loan, you might be able to stop paying MIP after 11 years if you made a down payment of at least 10%. It’s possible, however, that you may be stuck paying MIP until the loan is paid off.
One sure-fire way to eliminate mortgage insurance if you have an FHA loan is by refinancing to a conventional loan – as long as you meet lender requirements and have 20% home equity. And if you want to cancel PMI on a conventional loan, you can do so with a rate-and-term refinance if your home’s value has increased since your initial home purchase and you now owe less than 80% of what the home is worth.
Just keep in mind that you’ll have to pay additional costs to close on your new mortgage. So, you’ll want to weigh the costs of refinancing with the potential savings from canceling your PMI.
Factors To Consider Before Refinancing Your House
Are you thinking about refinancing your mortgage? In addition to the many reasons to refinance are some other considerations to keep in mind before choosing to refinance. They include:
- Current mortgage rates: Mortgage interest rates play a big role in determining the amount of your monthly payment and how much you’ll end up paying in interest when all is said and done. If current rates are low and a refinance can provide you with more favorable loan terms, be sure to compare lenders to find the best rate and term for your situation.
- The costs of refinancing: The cost to refinance a mortgage is usually between 2% – 6% of the loan amount, so you’ll want to weigh closing costs with potential long-term savings to determine whether a refinance is worth it. Common closing costs include an application fee, home appraisal fee, loan origination fee and title insurance.
- Refinance requirements: You’ll also have to meet lender requirements to refinance your mortgage. These include a minimum LTV, debt-to-income ratio (DTI), credit score and down payment.
The Bottom Line: Refinancing Can Be Beneficial Under The Right Circumstances
If you’ve ever wondered why you should refinance your mortgage, the picture is hopefully a bit clearer now. Refinancing your mortgage can help you secure a lower interest rate and lower monthly payments, plus it can allow you to tap into the equity you’ve built in your home. Before choosing to refinance, though, evaluate current interest rates, the total cost of refinancing and whether you meet lender qualifications.
If you’re ready to refinance your home loan, get started online to see if you qualify.