No one can predict the future. In the years following the day you close on your mortgage, interest rates could climb, plummet, or remain relatively stable. Plus, your income could change dramatically. As your circumstances and the terms available to you shift, it’s perfectly reasonable to wonder if a new loan might suit your current situation better than your existing loan. For this reason, many people choose to refinance. When you refinance your home, you pay off your current loan and replace it with a new mortgage. In some situations, this can greatly benefit the borrower. However, if you want to refinance successfully, you must weigh the pros and cons, gather information, and take all the little details into account (such as closing costs, extra fees, rate locks, etc). Scroll down to learn why and when to refinance your home.
Why to Refinance Your Home
To Get a Better Interest Rate
Interest rates rise and fall. If today’s interest rates are lower than the rate of your existing mortgage, refinancing can result in substantial savings, decrease your monthly payment, and allow you to build equity more rapidly. Traditionally, experts advised homeowners to refinance if they could lower their interest rate by 2 percent, but that is poor advice in many situations. These days, it might be worth refinancing if you can save even 0.5 percent (source).
To Shorten the Loan’s Term
When conditions for refinancing are favorable, some homeowners take their savings upfront in the form of smaller monthly payments. Others take a more long-term approach to savings; they continue to pay a similar payment in return for a shorter loan term. Paying off the loan in a shorter period allows you to build equity more rapidly and own your home free and clear sooner rather than later (source).
To Access Your Home’s Equity
Your home equity is a reflection of your home’s market value minus what you still owe on your mortgage. Ideally, both the value of your property and the portion of the mortgage that you’ve successfully paid off will increase, allowing you to build equity, but it doesn’t always work that way. In some cases, the market value of the property drops. And if it drops below the amount still owed on the mortgage, the homeowner is left with negative equity. If you have little or no equity, then tapping it isn’t an option.
However, if you’ve built up sufficient equity, then you have the option of refinancing to access that equity (source). Cash-out refinancing provides funds that can be used to consolidate debts or pay for major expenses like remodeling or a college education.
To Switch from an Adjustable-Rate to a Fixed-Rate Mortgage
Some people refinance to convert their loan from an adjustable-rate mortgage to a fixed-rate mortgage. Adjustable-rate and fixed-rate mortgages both have pros and cons; the best option depends on your situation. Adjustable-rate mortgages often start out with a lower interest rate than the one being offered for fixed rate mortgages, but over the years, periodic adjustments tend to trigger rate increases. Sometimes people refinance to switch to a fixed-rate mortgage and lower the risk that comes with a fluctuating interest rate (source). You could also refinance to switch from a fixed-rate to an adjustable-rate mortgage.
When is the Time to Refinance Your Home?
Wondering when to refinance your home? It all depends on your situation.
Refinancing for Rate and Term
Generally speaking, it is a good idea to refinance if you can get a significantly better interest rate or a shorter term. However, there is a cost to refinancing. Consider the cost of refinancing and your expected monthly savings. How long will it take you to break even? It may take years, so if you aren’t planning to stay in the house for quite a while, refinancing might not be the right choice for you. Try to refinance early in your mortgage term, when your payments are mostly directed toward your interest (source).
A cash-out refinance will give you a higher loan amount than your current mortgage. Although it can allow you to consolidate debts or make purchases that are important to you, it has consequences. If you use the funds gained to pay off high-interest credit card debt, you are saving on interest, but you’ve traded an unsecured debt for a secured one that puts your home on the line. If you use the money for purchases or investments, you have the advantage of your purchases, but you’ve reduced your equity and increased your debt to obtain them. Deciding when to refinance your home in this situation is a personal choice that depends heavily on your priorities (source).
Converting Between Adjustable-Rate and Fixed-Rate Mortgages
If you plan to stay in your home, you have an adjustable-rate mortgage, and you are concerned because the periodic adjustments are raising your interest rate, then you might want to convert to a fixed-rate mortgage to secure a lower interest rate and avoid worries about future rate hikes.
Alternatively, if you are considering selling your home in the next few years and interest rates are going down, refinancing your fixed-rate mortgage to switch to an adjustable-rate mortgage can make a lot of financial sense. You won’t need to continually refinance to enjoy smaller monthly payments as interest rates fall, because the periodic adjustments will reflect these changes. You also won’t have to worry about rates rising in the future because you will only have the mortgage for a few years.
Knowing when to refinance your home isn’t easy. There are many factors to consider, including current interest rates, future expectations for interest rates, how long you intend to stay in the house, your financial priorities, and your personal desires. Ultimately, you will need to weigh the risks and benefits of refinancing and make the decision that suits your unique situation best.
If you’re wondering whether you ought to refinance your loan, contact PrimeLending today. Our team can help you explore the pros and cons of refinancing, so that you can make the best decision for your situation. At our branches located throughout Kansas City, we can also help you decide the best way to refinance your mortgage. When you’re ready to learn more, please give us a call at 844-701-5626.