In the ever-evolving landscape of personal finance, one question often lingers in the minds of homeowners: Should I refinance my mortgage? With fluctuating interest rates and shifting economic conditions, the decision to refinance can be significant, potentially impacting your long-term financial well-being. There are many reasons a person would want to refinance their mortgage, all of which we will discuss below.
What is a Refinance of a Mortgage?
A refinance of a mortgage is replacing the existing mortgage with a new loan. The refinance process is a similar process to a home purchase with a few changes. Closing costs are usually put into the new loan to avoid borrowers needing to coming out of pocket for standard costs. You can learn more about the process here.
Why should I refinance my mortgage?
Decrease Your Interest Rate
Refinancing to lower your mortgage interest rate or principal and interest payment can be done without taking out cash. This type of refinance is called a “rate and term” refinance. Mortgage interest rates historically cycle through ups and downs – so if interest rates are lower now than when you first got a mortgage, this might really make a difference in your monthly payment.
Credit scores also play a big part in determining your rate. If your credit was lower when you first purchased your home, you might be able to secure a lower rate due to an improved score. Top-tier rates go to top-tier borrowers – specifically those borrowers with scores over 740.
Decrease Your Loan Payments
To reduce your monthly payment through refinancing, there are a few methods to consider. Lowering the interest rate can lead to significant savings in your budget. For instance, on a 30-year-fixed loan of $200,000, reducing the interest rate by 1% can result in a monthly savings of approximately $120.
Alternatively, you could refinance and extend the loan term while taking the remaining balance, which will also help you save money. Moreover, removing private mortgage insurance can further increase your savings.
Another way to lower your rate and loan payment is by buying down your rate. A rate buydown involves paying upfront interest at closing to secure a lower rate. Whether or not an additional cost at closing with a buydown would benefit you will come down to how long you plan to stay in your home. Our loan advisors can review this with you to see if this makes sense in your situation.
Eliminate PMI or MIP
If you put less than 20% down on your conventional loan or have an FHA that you got after 2013, you will have some form of mortgage insurance attached to your loan payments. These mortgage insurance premiums cost you extra money every month.
If you have an FHA loan and put more than 10% down, you will have insurance payments for 11 years; if you put less than 10% down, you’re looking at insurance payments for the life of your loan. However, if you’ve reached a point where you have 20% equity in your home, you can refinance to a conventional loan and eliminate those payments.
Similarly, with a conventional loan, if you put less than 20% down when you purchased your home, you will have Private Mortgage Insurance (PMI) payments in addition to your monthly principal and interest payments. With increasing home values and making your monthly payments, you may be able to remove PMI with a refinance.
Access Your Home Equity
Home equity is the amount of your financial interest in your home – meaning your home’s current market value minus any liens on that property. As you pay down your loan and increase the amount of equity in your home, your home’s value is also increasing. A cash-out refinance allows you to take some of that money out of your home. In general, you can borrow up to 80% of your home value.
Home Equity Example: Your home is worth $250,000 today. You have $100,000 remaining on your loan. In this scenario, you would have $150,000 in home equity.
Max Loan Amount: This is generally 80% of your home value. So, $250,000 x .80 = $200,000.
Subtract Loan Balance: The new loan will have to pay off your old loan, so take the new amount minus the old balance. $200,000 – $100,000 = $100,000.
Total Cash-out Available: $100,000
The amount you have available to borrow is determined by your home equity, so to establish that, your lender will need to order an appraisal to get your current home’s value. This is where if your home value has increased, you may be able to have more equity to borrow from.
You can use this lump sum of cash to consolidate debt, invest, make home improvements, and more.
Consolidating Your Debt
If you struggle with high credit card balances, are feeling the stress of a tight monthly budget and need to save money, or want to simplify your monthly payments, you may consider a cash-out. Consolidating your debt can give you breathing room and even help protect your credit.
Average credit card rates are now above 20%. It becomes very easy to see how paying off credit card debt in a home loan could save money.
Example: John and Peggy have a mortgage for $150,000 on a home worth $300,000. They have $40,000 in credit card debt. Since credit cards carry a high rate of interest, it makes sense for John and Peggy to put all of those balances into a new mortgage.
Once you consolidate, it’s important that you stick to a budget and don’t fall into the trap of racking up credit cards again. Check out a more detailed example of how you can use our refinance calculators to run the numbers and see if a refinance could help you save.
Refinancing To Purchase Another Property or Invest
Our homes usually will be our life’s greatest financial investment. It can also be used for collateral on loans with very low interest rates. Buying a second home, and investments in businesses are common reasons people would take cash from a refinance of their home. If you’re considering buying another property, whether as an investment or a second home, refinancing your primary residence could be the cheapest way to go.
A Cash-Out Refinance for Renovations
Another reason a homeowner might decide to refinance – even if rates are higher – is to get cash out for renovations. Home renovation projects can get costly, but a general rule of thumb is that if they increase your home’s value, pulling out funds could be worthwhile. Some bigger home improvement projects to consider for the highest return on your investment are HVAC upgrades, garage door replacement, kitchen and bathroom remodels, and more.
Of course, you have to compare getting a cash-out refi to a home equity line of credit (HELOC) to determine the cheaper option.
An alternative option to consider is making small improvements to your home with the money you save each month with a rate and term refinance that eliminates PMI. Improvements here to consider might be interior paint updates, new appliances, and landscaping projects to improve curb appeal.
Should I Refinance My Mortgage?
This is a question you’re probably asking yourself. There are a lot of reasons why you should refinance your mortgage. A basic measure here is that if you can save 1% on your rate, it’s a good time to refinance. The other thing to look at is how long it will take you to break even. If it takes you two years to break even, and you know you’ll be in the home for five years, it’s worth considering.
There is a legal concept protecting consumers called Net Tangible Benefit. It is the legal standard that protects consumers from predatory lending activities. Our mortgage loan officers must ensure the borrower has a net tangible benefit in a refinance. If this is not the case, the transaction is not lawful.
When Is the Right Time To Refinance?
Whether you’ve had your home a month or years you may struggle to know when the right time is to refinance or if it’s too soon to refinance. In truth, the answer is complicated and truly depends on the state of your personal finances, the state of the market, and how long you’ve been in your home. The waiting time from when you purchased varies based on the loan you have and whether you want cash-out. If you have these questions, your best bet is to contact one of our loan advisors and discuss your options.
In conclusion, your home is a great asset and one of your greatest investments. By refinancing, you can lower the cost of paying for your home and or use it to create new opportunities.
At Homestead Financial Mortgage, refinancing doesn’t require anything out of pocket, and often, you will have plenty of information before making a decision.