The main reason homeowners today refinance is to get a lower interest rate. But what many homeowners don’t realize is that refinancing helps them to rebuild the equity in their homes more quickly. For those of us who bought homes prior to 2006, most of us have less home equity than we used to because our homes are worth considerably less than they were a few years ago. Therefore, we have less home equity. Fortunately, refinancing can help homeowners to rebuild the equity in their home.
One of the quickest ways to rebuild equity is by refinancing your home mortgage, replacing it with a new loan that has a shorter term. While the shorter term loan means your monthly payment is larger, you’re actually doing yourself a favor by paying off your mortgage faster, paying less in interest and rebuilding the equity in your home simultaneously.
And with historically low interest rates, there’s never been a better, more affordable time to choose a short-term loan. In fact, with 15 and 20 year mortgages certain fees are waived if you’re refinancing an underwater mortgage through the federal Home Affordable Refinance Program (HARP), saving you more money.
But if you’re one of the homeowners who can’t afford a larger monthly payment on a 15 or 20 year mortgage, you can still save money each month and continue to build equity in your home with a 30-year-fixed-rate mortgage that has a lower rate than your existing mortgage. A new mortgage with a lower rate will allow you to make the same monthly payment but the extra cash will reduce your principle and increase the equity you have in your home.
Increased equity in your home has many advantages. With more equity in your home you’re in a better financial position to borrow money for medical emergencies or unexpected business opportunities with a home equity loan. Because the better your credit, the better your interest rate. Having more equity in your home also makes it easier to sell your home. When it comes to covering the down payment on your new home or covering the real estate agent’s fee and seller’s costs, you’ll have the money because of having more equity in your old home.
With enough home equity, you can get rid of private mortgage insurance (PMI) faster than you might otherwise have been able to do. PMI can be cancelled when the homeowner reaches 20 percent equity and refinancing with a shorter-term mortgage can get you there faster. PMI fees are the equivalent of paying an additional half percent in mortgage interest annually. So eliminating PMI is a significant savings. When you build equity in your home it brings you that much closer to owning your home free and clear. Not having a mortgage payment in retirement can be a huge benefit.
Refinancing to a shorter-term mortgage isn’t for everyone and shouldn’t be done unless you’re sure you can afford the higher monthly payment. Locking up too much wealth into your home is risky and you’ll want to be sure other financial needs can be taken care of like fully funding your retirement account, having a six month emergency fund and adequate insurance. That being said, refinancing can be a great financial strategy when done right.