Monday, July 20, 2020 / by Scott Coldwell
Getting a new mortgage to replace your existing one is called refinancing. The process of refinancing is very similar to getting the first one; it requires you to get a home inspection, an appraisal, and a title search, shop around for rates, go through an application process, and go to closing just as you did when you first bought your home. So why go through the process all over again? What’s the point? Put simply, most people refinance their mortgages to save money! Below, we have highlighted 5 reasons to refinance your mortgage that could save you thousands.
Reason 1: Lower Interest Rate
If you can refinance into a loan with a lower interest rate than you’re currently paying, you may have a significantly lower monthly payment. You can get a lower interest rate when they naturally sink (as they have in the first quarter of 2020) or if your credit has improved to the point where you qualify for a loan with a better rate. As a rule of thumb, it’s only worth refinancing if you can lower your interest rate by at least 1%, and you’re planning to stay in your home for at least a few years. The reason for this is you still have to pay, on average, 2%-5% in closing costs, which means you need to stay in your home for a few years to break-even. For example, if you paid $3,000 in closing costs for your refinance and, as a result, have a $100 decrease in your monthly mortgage payment, it would take 30 months to break-even.
Reason 2: Shorten The Loan’s Term
Another sound reason to refinance is to shorten a loan’s term. When interest rates take a dip, some homeowners have the opportunity to refinance their mortgage to a significantly shorter term without much change to their monthly payment.
Reason 3: Tap Into Equity To Payoff Debt
Refinancing to tap into the equity in your home to consolidate debt, is a slippery slope, but can be useful. This is one of the reasons real estate is such a powerful tool! At face value, replacing high-interest debt with a low-interest mortgage is a good idea. While accessing the equity in your home is a valuable tool to bring your debt under control, it does not give you financial prudence.
Reason 4: Convert The Loan Type
Converting a loan to an Adjustable Rate Mortgage (ARM) or Fixed Rate Mortage (FRM) can be useful depending on your situation. ARMs often start out with lower rates than FRMs, but they increase over time and tend to go above the FRM rate. Converting your ARM to an FRM could save money and eliminate the concern that your rate will make a drastic hike in the future. By contrast, if you do not plan on staying in your home for very long and mortgage rates are falling (like they have this year), changing your FRM to an ARM could save you money every month, and you won’t have to worry about what the rate will be in 30 years since you will be moving soon.
Reason 5: FHA Loan To Conventional Loan
FHA loans often require insurance for the entire life of the loan, even after you’ve built up substantial equity, whereas a conventional loan no longer requires insurance if the owner has at least 20% equity in the home. Switching your loan from FHA to conventional one could save you money by eliminating the cost of insurance.
As you can see, there are many reasons people choose to refinance their homes that all revolve around saving or gaining money. However, not all of these scenarios will work in your favor, so be sure to speak with a financial advisor and run the numbers to understand if changing your mortgage is worth it.