Refinancing is when a loan is paid off in full and replaced with a new loan that has different terms. Refinancing can be done for many reasons but may not always be beneficial. This article will walk through the some of the best reasons to refinance a loan so you can determine if refinancing makes sense for you.
Refinancing Basics
Refinancing can cost between 3-6% of the homes price, so you want to make sure you are refinancing to save more money in the long term. Alongside the percent fee that must be paid, there are plenty of other costs associated with refinancing including application fees, appraisal, title search, etc. Due to the multiple areas in which refinancing can cost more money, it is important to use a refinance mortgage calculator and ensure you are making a smart financial decision before diving in.
The scenarios are when refinancing makes the most sense for your wallet.
#1. Mortgage rates are lowering
If your original loan has a much higher interest rate than what is currently the average market rate then it would be wise to refinance. Professionals say that if you can lower your mortgage rate by at least 1% then it pays off in the long run. Better yet, if you can lower your interest rate by 2% then you are golden!
Attaining a lower interest rate means you will be paying less interest over the life of your loan and therefore saving money. A lower interest rate can also lower your monthly mortgage payment and help you build equity quicker since more of your money is going towards the principal rather than the interest.
#2. Switching from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage
If interest rates are rising and you have an ARM, then it would be wise to refinance to a fixed-rate mortgage. This is due to the fact that as interest rates rise, so does your monthly mortgage payment. When you refinance to a fixed-rate mortgage, you then lock in a set interest rate and no longer run the risk of super high interest.
On the other hand, if you have a fixed-rate mortgage and interest rates are dropping it could be financially beneficial to you to switch to an ARM because as interest rates lower, your monthly mortgage payment lowers. This gets rid of the hassle of having to keep refinancing every time the interest rate lowers. Of course, this is risky and no one can fully predict interest rates but there is a plethora of information out there to help you make your decision.
#3. Change in the loan period
If you want to refinance your loan to a lower interest rate, another beneficial thing is that you could also lower the life of the loan (30 years vs. 15 years) and depending on how much your interest rate dropped, you may not even experience a difference in your monthly mortgage payment. This is best to do when the mortgage is on an asset that you would like to either rent out or earn an income from since the sooner the loan is up the sooner you can keep all of your profits instead of having to pay a mortgage.
#4. Consolidate debt
If you have a couple of large loans out there, it might be wise to try to refinance to put it all under one service and one interest rate. This obviously makes your life easier since you only have to look at one monthly payment and don’t have to worry about paying multiple different bills. This would not be worth it if it increases your mortgage interest rate but lowers other interest rates. You will want to compare the total amount of each loan, it’s the interest rate and the life of the loan prior to consolidating.
Final Thoughts
Refinancing can be incredibly beneficial for homeowners when done at the right time for the right reasons. It can also be costly and time-consuming. Don’t refinance just to refinance. Refinance to save your future self money. Have you refinanced? If so, let us know in the comments below!
Gina DiMasi
Gina DiMasi is an organizational finance whiz. Gina is an avid investor, educator and aficionado of bitcoin and other modern investments. In addition to being an all around nice person, Gina has a degree in personal finance studies from Framingham State University. When she's not running numbers or blogging up a storm, Gina actively volunteers with Habitat for Humanity.
What if you want to take cash out to get more real estate?
Hi James!
Yes exactly. The BRRRR (buy-rehab-rent-refinance-repeat) is a strong real estate strategy that does require refinancing. This article still applies to those looking to refinance for their property using the BRRRR strategy. You wouldn’t want to refinance just to get the money out and end up not having enough in the monthly rent amount to cover the monthly mortgage. Timing is very important when it comes to a BRRRR which is why this article would still apply to those investors participating in that strategy.
Thanks for the comment!