If you’re a home owner with an existing mortgage, you’ve probably heard people tell you about the benefits of refinancing your loan. And while refinancing can be extremely beneficial, it’s not always the best idea for everyone. Knowing the benefits to refinancing can help you make the decision if it is the right option for you.
What is a Refinance?
A refinance is when an existing loan is paid off and replaced with a brand new one. The primary benefits of refinancing a mortgage include:
- Acquiring a lower interest rate
- Diminishing the duration of a loan
- Switching an adjustable rate mortgage into a fixed rate mortgage (or conversely, and fixed rate into an adjustable rate)
- Accessing equity in their home
Refinances do cost a little bit of money though, typically 3% – 6% of the loan’s principal balance. And, like an initial mortgage, appraisals and fees are often required.
Getting a Lower Interest Rate
The most common benefit of refinancing a mortgage is obtaining a lower interest rate. It’s generally accepted that if refinancing will decrease your current rate of interest by at least 2%, then you should consider refinancing.
Not only will a lower interest rate help you save money, but it will also help you build equity at a faster pace. A lower interest rate will also lower your monthly payments.
Reducing the Duration of Your Mortgage
A refinance while interest rates are falling can result in a shorter loan term without much change to your monthly mortgage payments.
Transferring a Fixed Rate into an Adjustable Rate (Or Vice Versa)
The draw to adjustable rate mortgages (ARMs) is they are typically offered at a lower interest rate than a fixed rate mortgage. The interest rate on a ARM fluctuates according to the market. So, while you may start out with a really low interest rate, it could increase over time due to market trends, sometimes higher than the initial fixed mortgage rate you were offered.
Refinancing, and converting your ARM into a fixed rate mortgage can reduce the interest rate down to a more reasonable digit. Plus, the constant nature of a fixed interest rate can make budgeting one’s finances easier and much more predictable.
Converting a fixed rate into an ARM isn’t as common, but if interest rates appear to be falling dramatically, it could be a smart move. Refinancing to an ARM might be beneficial if you don’t plan on staying in your home for a significant period of time.
Tapping into Your Home Equity
If a homeowner has a significant amount of home equity saved up, it’s common for them to tap into it via refinance to help fund other expenses, such as medical costs for school tuition. Sometimes this money is used to remodel the home, in hopes that the new additions will help raise the value of the home when it comes time to sell.
Final Thoughts
Refinancing can be an effective way to save you money in the long run. Just remember that refinancing does come with additional fees. And it can be quite a while before the cost of those fees are recouped. But if you plan on staying in your home for a long time, then refinancing might be the right option for you.
Source: https://www.investopedia.com/mortgage/refinance/when-and-when-not-to-refinance-mortgage/
