Refinancing a mortgage means paying off your existing loan and replacing it with a new one. There are a number of reasons why home owners want to refinance their mortgage which typically include getting a lower mortgage interest rate, shortening the mortgage term or change the mortgage type from an adjustable rate mortgage to a fixed rate mortgage or vice versa.
Mortgage rates in United States are at historical lows. Refinancing while mortgage rates are this low can really save you thousands of bucks. However, this is true only under certain conditions. Let’s discuss here in detail when you should and when you should not refinance your mortgage depending on your personal mortgage situation.
Refinancing your Mortgage
Refinancing your mortgage means paying off your current mortgage and obtaining a new one in efforts of getting a better interest rate, changing your mortgage company, lower your monthly mortgage income, or change your mortgage term. The purpose is to get more favorable terms.
As you already own your home, the process of refinancing your mortgage is comparatively a lot easier that to get approved for your first home mortgage.
Most people opt. to refinance when they have equity in their home. Because a substantial equity makes the refinancing process whole lot easier. Equity is the difference between the amount owed to the mortgage company and the worth of the home.
The cost of refinancing is the key factor in determining when and when not to refinance your mortgage. Refinancing your mortgage comes with as many costs as the original mortgage which include closing costs, attorney’s fees, appraisal cost, and other taxes.
Many mortgage lenders claim a “no cost” refinance mortgage but this is certainly not the case in reality. What you can get here is a refinance with no money paid upfront, and the above mentioned costs will be incorporated into your loan.
The important thing to do here is to determine whether the savings from your new mortgage with lower interest rate offset the refinancing costs or not.
When to Refinance
It is true that you can save a lot of money by refinancing your mortgage as the current interest rates on mortgage are extremely low. But it varies for different mortgage situations.
So, if you want to refinance your mortgage, make sure it offers you the benefits listed below compared to your current mortgage loan.
- Lower Interest Rate
The most important reason why most people want to refinance their mortgage is to get a lower interest rate. As, this ultimately decreases the monthly mortgage payments, which means you will eventually have more spare money every month to invest in other things. For example, a 30-year fixed-rate mortgage with a home value of $100,000 and an interest rate of 9% has a principal and interest payment of $804.62. The same loan with 4.5% interest rate (current rates) reduces your payment to $506.69.
- Shortening your Mortgage Term
Another good reason to refinance mortgage is to shorten your mortgage terms. If the interest rate for your new mortgage is lower than your original mortgage, and you are willing to pay the same amount each month as your monthly mortgage payment. It will radically reduce the amount of time it will take to pay off your mortgage. For example, refinancing from 9% to 5.5% of a 30-year fixed-rate mortgage on a home value of $100,000 can cut the mortgage term to half i-e 15 years with only a slight change in monthly mortgage payments from $804.62 to $817.08.
- Change mortgage type from Adjustable-rate to Fixed-rate
Depending on the current mortgage rates, you can chose a mortgage type with more favorable terms. For example, you may shift from an unpredictable adjustable rate mortgage to a fixed-rate mortgage at better terms or vice versa.
- Refinancing to tap equity
If you have built up equity on your home, you may refinance your mortgage to cash out on that equity. This is useful when you have to consolidate a debt or you need money for other important purposes like paying off your kid’s college tuition fee etc.
When Not to Refinance
Refinancing your mortgage is a good idea in most circumstances but it may not always be the case. If refinancing your mortgage can lead to one of the following cases, it is a better idea to stick to your current mortgage or refinance your mortgage at some other point.
- Refinancing Costs outweigh the savings
If the savings from your new mortgage loan do not offset the refinancing costs. It is a better idea to stick to your current mortgage. There should be a significant gain in terms of money if you want to refinance your mortgage. Otherwise, it will not be worth it to go through the whole process of mortgage application again.
- Longer Mortgage Term
If you have already completed 10 years or more of your current 30-year mortgage and want to replace it with a new one of same typical 30-year mortgage term. It will no doubt will reduce your monthly mortgage payments but will increase your mortgage term and you might end up paying more in total.
- Credit Traps
If you refinance your mortgage to cash out the equity in your home to invest in renovation or to pay off your credit card debt. It may sound smart at that particular instance but is really not a great choice.
It is possible that you spend all this money in less important stuff and end up not being able to afford your monthly mortgage payments which can cause you to lose your home.
- You are Enticed by the “No Cost” Refinance
Although, it may sound promising but there is no such thing as no cost refinance anywhere. Every refinance mortgage comes with costs that have to be paid either in cash or as a part of your loan.
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