Refinancing a home can be a wonderful way to improve your financial situation, lower your payments, or receive the necessary funds for a large investment.
However, there are a few things you need to know before you commit to refinancing your home.
There’s a lot more to refinancing a home than simply lowering your payment, getting cash out, or getting a lower mortgage rate. Keep reading for an in-depth look at everything you need to know when refinancing.
1. There Are Multiple Reasons to Refinance
There are many reasons why you might want to refinance your mortgage. Most reasons center around improving your financial situation in one way or another.
Here are the most common reasons people choose to refinance.
Reduce Interest
You may be able to refinance your loan with a lower interest rate. This is a great way for homeowners to save a substantial amount of money throughout the length of the loan.
For example, a $250,000 home with an interest rate of 4.0 over the course of 30 years will actually cost you $429,673.77. That’s roughly $180,000 paid on interest alone – which is roughly the price of a second home.
A home at $250,000 at a lower interest rate to 3.25, however, would only cost a total of $391,685.69. That’s a savings of nearly $38,000.
Mortgage rates change based on a variety of market and economic conditions. Also, rates depend on a variety of factors including the loan to value, credit, cash out, and the type of mortgage product. Find out what you qualify for.
Reduce Monthly Payments
One of the best things about refinancing your home is that you can use it to lower your monthly mortgage payments.
This is, of course, assuming you don’t use the refinance to take out cash against the equity. However, if you refinance the loan based on what you owe and receive a lower interest rate and payment, it could save you hundreds of dollars each month.
Reduce the Length of the Loan
If your financial situation has improved and you can afford higher mortgage payments each month, you could refinance to reduce the length of the loan.
While you may wonder why you would want higher monthly payments, think of it in terms of the total cost of a 15-year loan versus a 30-year loan.
Using the same example as above, a $250,000 home at 4.0 percent interest over 30 years would cost $429,673.77 when all is said and done.
That same home at 4.0 percent interest over a 15-year loan would only cost $332,859.57. You would be saving nearly $100,000 in interest by opting for a 15-year loan.
For reference, a 30-year loan would require monthly payments of $1,193.54, while a 15-year loan would require monthly payments of $1,849.22.
Consolidate Debt
If you meet the refinance requirements and have a decent amount of equity in your home, refinancing may be a brilliant way to consolidate high-interest debt into your low-interest mortgage.
For example, the average American has over $5,000 in credit card debt at a typical interest rate of 19 percent.
Other loans and debts have equally high-interest rates. If you could refinance your home and use the positive equity to absorb those debts under a lower interest rate, it could save you thousands of dollars.
Additionally, using a refinance to consolidate your other debts will likely lower your total monthly payments.
Take out Cash Equity
While it’s not always recommended, some people refinance their home to take cash equity out of their home’s total value.
This can be done to make larger investments such as second homes, businesses, or remodeling.
Receive a Home Equity Line of Credit
Some homeowners refinance their homes to take out a HELOC or home equity line of credit. These are typically used to upgrade or renovate the home in some way. This includes bigger projects such as updating an entire kitchen or bathroom, creating more outdoor living space features, adding rooms onto the house, and more.
This can be looked at as a good investment, as these updates and renovations also serve to further increase the value of the home.
Revert From an ARM to an FRM
Finally, you can use a refinance to change your adjustable-rate mortgage to a fixed-rate mortgage. This can be a wise move for homeowners who are planning on staying in the home long-term and want to lock in a low-interest rate.