Refinancing a mortgage refers to repaying an existing home loan and replacing it with a new loan with different terms. There are several reasons for homeowners to consider loan refinancing, including:
To lower their rate of interest
To shorten the tenure of their loan
To move to a fixed-rate mortgage from an adjustable-rate mortgage
To tap into the equity they’ve built up in their home
Since refinancing can cost anywhere between 3% and 6% of the principal — as in the case of an original mortgage — it’s important for homeowners to be sure that refinancing is the right financial decision for them.
Refinancing to Get a Better Interest Rate
A good rule of thumb to keep in mind is that refinancing only makes sense if your new rate is at least 1% lower than your current rate. Even then, if you’re almost at the end of your loan term, you may end up incurring more expenses by refinancing. Use a mortgage loan calculator to determine if the costs are worth it.
Refinancing to Shorten the Tenure of The Loan
When interest rates drop, homeowners may be able to refinance to a loan with a shorter term without increasing their monthly payment by too much. For instance, if you have a 30-year mortgage on a $100,000 home and you pay a fixed rate of interest, refinancing from a loan with a 9% rate to one that has a 5.5% rate can cut your term in half to just 15 years. The best part is that your monthly payment will increase only marginally from $805 to $817.
Refinancing to An Adjustable-Rate Mortgage
Oftentimes, adjustable-rate mortgages start out with low APRs that gradually increase over the course of the loan term. When this occurs, refinancing to a lower-rate fixed-rate mortgage may help you save money on interest payments.
Refinancing to Cash out Equity
Homeowners who have already built enough equity can tap into it to cover major expenses. Keep in mind that refinancing to take out more debt can be a slippery slope. However, it is sometimes the best option.