Because refinancing can cost between 3 percent and 6 percent of a loan's principal and, as with an original mortgage, it necessitates the completion of an appraisal, a title search, and the payment of application fees, a homeowner must determine whether refinancing is a wise financial decision before proceeding.
Refinancing to Secure a Lower Interest Rate
One of the most compelling reasons for refinancing is the opportunity to cut the interest rate on your current mortgage loan. If you can cut your interest rate by at least 2 percent, it has always been thought that refinancing is a good option, according to conventional wisdom. On the other hand, many lenders believe that a one percent savings are sufficient motivation to refinance. A mortgage calculator is a useful tool for estimating some of the expenses associated with a home purchase.
Loan Refinancing to Reduce the Loan's Term
When interest rates are falling, homeowners may be able to refinance an existing mortgage for another loan that has a much shorter term while requiring very little change when it comes to monthly payments. They may be able to justify the refinancing by demonstrating that renovation increases the value of the house or by demonstrating that the interest rate on the mortgage loan is lower than the interest rate on money borrowed from a different source.
In the case of a $100,000 property with a 30-year fixed-rate mortgage, refinancing from 9 percent to 5.5 percent may reduce the term by half, from 30 years to 15 years, with just a modest increase in the monthly payment from $805 to $817. A 3.5 percent mortgage for 15 years will bring your monthly payment to $715 if you are presently making $568 on a 5.5 percent mortgage for 30 years. So crunch the numbers and see what works for you.
Refinancing to Switch to an ARM
However, although adjustable-rate mortgages (ARMs) often start with lower interest rates than fixed-rate mortgages, periodic rate adjustments may result in rate rises greater than the rate attainable via a fixed-rate mortgage if the loan is not paid off. Consequently, changing to fixed-rate mortgages results in a cheaper interest rate and removes the possibility of rising future interest rates. In contrast, converting from a fixed-rate loan to an adjustable-rate mortgage (ARM), which typically has a lower monthly payment than a fixed-term mortgage, can be a sound financial strategy if interest rates fall.
These homeowners will be able to lower their loan's interest rate and their monthly payment, but they will not have to be concerned about how increased interest rates may affect those 30 years from now. If interest rates continue to decline, the periodic rate adjustments on an ARM will result in lower rates and fewer monthly mortgage payments, removing the need to renew every time rates fall. If rates continue to fall, when interest rates on mortgages climb, this would be a bad tactic to use.
Refinancing to Take Advantage of Available Equity
Even though the reasons for refinancing listed above are all sensible financial decisions, refinancing a mortgage may be a slippery slope into a never-ending cycle of debt. To meet big expenditures, such as the price of a home renovation or a child's college tuition, homeowners often borrow against the equity in their houses. They may be able to justify the refinancing by demonstrating that renovation increases the value of the house or by demonstrating that the interest rate on the mortgage loan is lower than the interest rate on money borrowed from a different source.
The fact that mortgage interest is tax-deductible is an argument favoring borrowing money. While these reasons may be valid, extending the number of years you owe your mortgage is seldom a wise financial move. Spending a dollar on interest to get a 30-cent tax deduction is rarely a wise financial option. It would help if you also keep in mind that since the Tax Cuts and Jobs Act went into effect.
Refinance to Consolidate
A large number of homeowners refinance to consolidate their debt. The notion of replacing high-interest debt with a low-interest mortgage seems to be a smart one on the surface. Unfortunately, refinancing does not automatically result in increased financial prudence. Take this step only if you are certain that you will be able to resist the desire to spend after you have been debt-free for some time.
