Refinancing Your Mortgage: How, When & Why?

A home may be your most expensive and most crucial investment, and for most homebuyers, a mortgage can make this purchase possible. There are several compelling reasons to consider refinancing your mortgage. Refinancing can be a way to meet significant financial goals.

However, before diving into the process, it’s smart to take a step back and make sure you understand the ins and outs. This will allow you to see the bigger picture and develop a strategy to achieve the best possible outcome for you.

Mortgage refinance may seem like a complex topic, but it’s basically taking out a new mortgage to pay your existing one.

It’s a loan with a new principal and a different interest rate. But since it takes the place of your original mortgage, you’ll only have one monthly payment.

When you apply to refinance your home, your lender will check your credit score. They’ll also review your income and tax history and assess your home’s current market value.

Lenders put all this information together to see whether you qualify for a loan. If you do, they’ll provide several options. These may include a lower monthly payment, a shorter term length or taking equity out of your home.

Refinancing your mortgage might seem like a risky move, but there are several reasons why you may consider it.

A mortgage refinance may allow you to get lower interest rates. Even half a percentage point can make a significant difference over the life of your loan. If you’re planning to live in your home for the foreseeable future, you can make this work to your advantage.

You could find yourself in a situation where you need to fulfill a financial obligation immediately. This could include paying for college tuition or a medical emergency. Refinancing your mortgage allows you to tap into your home’s equity and take it out as a lump sum. You can use the cash to pay off existing debts with high interest rates.

The section below outlines a comprehensive list of factors to consider. You’ll find more details about why a mortgage refinance may be a solid financial decision for you.

There are numerous benefits to refinancing your mortgage. While most of them revolve around reducing your monthly payment, a new mortgage can have a shorter term, stabilize your payment with a fixed interest rate or help you use the equity you have built up in your home. These are the most common reasons homeowners decide to refinance:

• Reduce your payment through lower interest: If your current interest rate is higher than today’s rates, you could save money through refinancing. For example: Refinancing a $250,000 mortgage to lower the interest rate from 6% to 3% could save you over $400 per month.
• Reduce your payments by eliminating PMI: Purchasing your home with less than a 20% down payment means you will probably pay private mortgage insurance (PMI) in addition to principal and interest. Once you have 20% equity built-in, refinancing can cut out the PMI payment, unlocking more savings.
• Shorten your mortgage length: If you are considering selling your home or want to get out from under monthly payments, shortening your mortgage length can help you get the most from your home. Converting from a 30-year mortgage to a 15-year home loan will help you build equity faster.
• Converting to a fixed rate: While adjustable-rate mortgages (ARM) are great for the initial term of 3–5 years, the monthly payment can spike once it’s over. Refinancing an ARM can give you a fixed rate for 10, 15 or 30 years. You’ll know your monthly payment won’t change, allowing you to build a balanced budget for your home.
• Take cash out from home equity: Are you considering remodeling your home, paying off high-interest credit cards or going on vacation? Your home can help you get the money you need to achieve those goals. If you have over 20% equity in your home, you can use a cash-out refinance to borrow against your equity to cut down on bills, invest in the value of your home or go on that once-in-a-lifetime trip.

In most cases, homeowners can refinance their homes at any time to take advantage of savings or draw on some of the equity for other use. Before signing any papers and making it official, it’s critical to understand all the costs of refinancing. These include going over your credit profile, understanding your credit score, finding the refinance quote that reflects your best options and determining how much you will pay in upfront costs.

Despite all the benefits you can get if you refinance your mortgage, you’ll also want to consider potential drawbacks. Here are the major ones to think about before you take action:

• New closing costs and fees: You will be responsible for refinancing costs for your new loan. Closing costs and fees for things like home inspections can add up quickly. You can roll some of those into the loan, but keep in mind that doing so will affect your monthly payment and could erode your savings.
• A lower rate could have higher fees: Getting the lowest interest rate often requires paying “points” towards your loan. You may need to pay cash out of your pocket to lock in your loan.
• Prepayment penalties: Some mortgages have prepayment penalties, meaning you’ll pay more if you decide to pay off your principal balance early. It’s smart to be sure you understand the terms and conditions before closing on your new loan.
• Longer break-even point: Extending the life of your mortgage by several years could push your break-even point further into the future, depending on how long you intend to live in your home. It’s a good move to use a refinance calculator to estimate your total savings and when you can actualize them.
• Underwater loans: If you take out too much money, you risk having a mortgage that is higher than your home’s value. When this happens, it’s known as “going underwater.” To avoid this trap, it’s important to understand the actual market value of your home before you sign loan documents.

Timing is crucial in refinancing, and it’s best to pursue it when conditions work in your favor. However, it never hurts to begin preparing before the right time comes. This way, you’ll be ready to start the process immediately when you’re ready.

Here are some situations when a mortgage refinance is a good idea:

• Refinance when you find lower interest rates: Several factors affect your monthly mortgage payments. Your interest rates have the most considerable effect. Finding rates even half a percentage lower can dramatically reduce your monthly payments.
  
  You can use your current interest rates as a starting point. Check with different lenders, and if you find lower rates, it might be a good time to refinance your mortgage.
  
  
• Refinance when your credit score increases: Lenders use your credit score to evaluate your creditworthiness. A good credit standing usually means you’ve managed your finances and debt obligations well.
  
  Your credit score improves as you make your monthly payments on time and in full. Check your credit score and compare it to when you first took out your mortgage (or a shorter period). A better credit standing may mean better refinancing options are available to you.