Here’s When to Refinance Your Home… and When to Avoid It
Mortgage interest rates are a little better than they were a year ago, but they remain higher than they’ve been in two decades. Still, there are many homeowners out there who might find the prospect of refinancing their mortgages appealing for a number of different reasons. After all, there are a lot of mortgage loans out there with interest rates that are even higher what’s currently available, so these homeowners can potentially save money by refinancing.
But of course, before you choose to refinance your mortgage, it is important to assess your situation and consider your reasons for wanting to refinance because some reasons are simply better than others. And some reasons can even be detrimental.
Here are the best and worst reasons to refinance your home mortgage.
The Best Reasons to Refinance a Mortgage
When you refinance your mortgage, you are essentially using a new loan to pay off your old one. So, for the transaction to make sense, there needs to be something that you want to achieve that will in some way benefit you. As a result, the best reasons for refinancing tend to include:
- Getting a lower interest rate on your loan
- Eliminating mortgage insurance
- Accessing cash from the equity in your home
Getting a Lower Interest Rate on Your Loan
If you can get a loan with an interest rate that’s just one percent lower than your current rate, then you can save a sizable amount on your monthly loan payment. This type of refi is what’s known as a “rate-and-term” refinance.
If you’re able to get a shorter-term loan at a lower rate, then you can potentially save money and pay of your loan faster than your current loan’s schedule. As you might expect, this is one of the most common reasons why homeowners choose to refinance their mortgages.
Eliminating Mortgage Insurance
Homeowners who bought their homes without putting at least 20 percent down pay private mortgage insurance (PMI) as part of their mortgage payment every month. You will continue to pay this charge until you reach 20 percent equity in your home, but even then you will need to contact your lender and ask them to remove it.
Another way to remove it is to refinance your mortgage. If you have 20 percent or more equity in your home, then you can refinance your mortgage at a lower rate and get your loan without mortgage insurance included. Combined, this can amount to substantial savings.
Accessing Cash from the Equity in Your Home
If your home is in need of renovations and you have more than 20 percent equity, then you can apply for a cash-out refinance to access the funds you need to improve your home. While this type of refinance will result in you having a larger loan balance than you did previously, if the money is used wisely on certain home improvements, then the value of your home will also be higher than it was.
Choosing to access your home’s equity to fund your renovations instead of applying for a personal loan is preferred because you can usually get your loan at a lower interest rate and you’ll have just one monthly payment to make instead of two.
The Worst Reasons to Refinance a Mortgage
Not every reason to refinance is a good one. In fact, some reasons can even increase your risks and your financial health. Here are some of the worst reasons to refinance your mortgage.
Consolidate High Interest Credit Card Debt
Carrying a lot of credit card debt is understandably stressful, especially when the interest rates on those cards are high. While some homeowners might choose to refinance their mortgages to pay off their credit card debt, this puts them at risk. The reason is because you’re using secured debt to pay off unsecured debt. Your mortgage is a secured by your home, so if you can’t make your payments, the bank will foreclose and take ownership of the home. Plus, if you already have an unhealthy relationship with money, there is always the risk that those credit cards will be used again after they’re paid off, thus resulting in more high-interest debt.
Purchase Luxury Items
Some homeowners choose to access their home’s equity because they want to make a major purchase, like a new car, an RV, or a luxurious vacation. While this can be tempting, it can ultimately be a terrible decision. The reason is because your new loan will be larger than what you owe on your current loan, so even with a lower interest rate, your monthly payment will most likely be higher. You will lose the equity you worked so hard to build without gaining any benefit in home value and the assets you purchased will quickly depreciate.
Extend the Terms of Your Mortgage
If you have ten years left to pay on your current mortgage, then you might be tempted to refinance into a new loan at a lower rate and a longer 30-year repayment term. While this will reduce your monthly payment quite a bit, you will be resetting the clock on your goal of owning your home. Instead of ten years, you will now have to make monthly payments for 30 more years, and a lot can happen over that time.
Refinancing After a Recently Purchasing the Home
If you purchased your home recently, but the interest rates are lower now than what they were when you did, then you might be tempted to refinance to get that lower rate. This isn’t advisable because the only one who usually benefits is the lender. You will need to pay closing costs and other fees on your refinance, and this can offset any savings you were hoping to achieve.
What are Your Reasons for Refinancing?
Refinancing your mortgage is usually only worth it if you can make your mortgage payment more affordable or get the you cash to meet other financial goals, like improving your home’s market value. That said, everybody has their own reasons for wanting to refinance.
Before you move forward, make sure you evaluate your reason for wanting to refinance and weigh the costs, benefits, and risks. Your refinance will only be successful if you can come out in a better place financially than you are currently.
