Best reasons to refinance a home loan.
With mortgage rates nearing an all-time low, it’s a no wonder why people are looking to buy new homes and refinance their existing mortgages. It was only a few years ago that rates hovered around 6-percent. Across the board today’s home loans are nearly half that, and as low as 3-percent annually.
Since the early 80’s people have been refinancing. It’s an opportunity to replace your current home mortgage with a new loan that offers substantial savings over the course of the entire loan. There’s costs associated with refinancing, such as getting an appraisal on your home’s value, but overall it’s an effective way to save money.
Below are the five best reasons to refinance your mortgage.
#1. Lower your monthly payments
Getting a lower interest rate is the biggest reason homeowners want to refinance. Mortgage rates in 1980’s were as high as 18-percent, and in the 1990’s they hovered around 8-percent. By refinancing you can lock-in a cheaper interest rate for the remaining duration.
Keep in mind that even though your monthly payment goes down, it’s usually not a good idea to extend the loan term. By adding years you will probably end up paying more money over the life of the loan.
#2. Switching to a fixed rate loan
If you opted for an adjustable rate mortgage (ARM) when you bought your home, you might want to switch to a fixed rate mortgage and lock-in the rate. It’s hard to imagine rates getting any lower than they are right now.
#3. Pay off your mortgage faster
If you can afford to pay more and want to skip the prepayment penalty it’s a good idea to refinance your home. The shortened repayment schedule can save you a lot of money, especially if you have a 30-year mortgage, or a significant amount of years left.
Depending on the number of years left on the loan, you may want to negotiate the prepayment penalty. You can also lower your monthly payment by “buying down the rate” with discount points.
Discount Points: Also known as mortgage points, it’s an amount you pre-pay at closing to lower your monthly payments. Each “point” equals 1-percent point of the loan amount.
#4. Get out of paying mortgage insurance
For homeowners who opted to pay less than a 20-percent down payment, a lender may have required private mortgage insurance, or PMI. This additional monthly expense is typically 0.5% to 1.0% of the total loan amount.
By refinancing you can possibly eliminate this added cost, especially if you convert your FHA home loan into a conventional mortgage.
** The most important factor is that you have 20-percent equity in your home when you refinance.
#5. Borrow from your home equity
If you’ve paid off enough of the principal, you may be able to borrow from the available equity in your home to get a cash-out refinance.
For example, you may want to remodel your bathrooms or kitchen to add value to your home or use it to pay off a debt with higher interest (such as credit card debt). Just be aware that how you plan to use your home equity to pay for things will affect the overall interest you pay (by extending the length of the loan).
Dangers of refinancing a mortgage
Here are some things to think about before you go ahead and refinance.
- Pick a reputable mortgage lender and refer to their guidance. Don’t be afraid to ask questions about loan terms, rates, or and the monthly costs.
- You’ll have to go through the loan approval process again.
- Personal debt-to-income ratio and your credit score will be re-evaluated.
- Fees associated with refinancing a mortgage loan include a home appraisal, credit report check, processing fees, underwriting, and admin fees. Understand all the costs before signing off on it.
- Watch your break-even point. This is how long it takes for a reduction in your monthly payments to equal the cost of refinancing. If you plan to sell your home before the break-even point is reached, you probably won’t recover these costs. Let’s say your refinance costs total $5000, and refinancing lowers your monthly payment by $200, it’ll take 25 months before the refinancing ends up saving you money.
- Most banks and lenders require you to have a minimum of 20-percent equity in your home to qualify for refinancing, either from principal you’ve already paid or from the updated home appraisal value.
- Refinancing may add to the term length of your loan. This can increase the total amount you pay over the life of the mortgage.
Even with all of the downsides, refinancing today is probably worth doing.
If you’re ready to refinance, make sure the factors are in your favor. Do the math backwards and calculate how much you’ll save over the entirety of the loan. What’s your break-even point? Can you afford to pay it off faster?
Also make a list of the factors you want to negotiate such as discount points, or prepayment penalty charges. Understanding the intricate details of refinancing and having a professional opinion is key to cutting your overall costs.