When you purchased your home, you applied for a mortgage that came with set rates and monthly payments to pay back your lender. But what if your financial situation changes, and you have the opportunity to lower that monthly payment and interest rate?
As a homeowner, you have the option to refinance your mortgage. And, along with the possibility to lower your interest rate and monthly mortgage payments, refinancing your mortgage can be a way to access more home equity to help fund your financial goals. But it’s not always the best option for everyone. Read on to see what to consider first.
What Does it Mean to Refinance a Mortgage?
When you refinance a mortgage, you’re basically trading in your existing mortgage for a new one, leaving it up to your bank or lender to pay off your old mortgage. By refinancing, you could land a lower monthly mortgage payment and better interest rate, making it an enticing option, especially for borrowers who are in a better financial position than when they first secured a mortgage.
How Does the Refinancing Process Work?
The process to refinance your mortgage is very similar to that of securing a mortgage in general, meaning you’ll need to reapply. So it’s a wise idea to first ensure you have good credit, and the necessary funds to pay for associated costs, like a home appraisal, lender fees, and closing costs.
To start the process to refinance your mortgage, begin by doing your research and comparing interest rates and loan terms with multiple lenders to find the best possible offer. Then, compare those new offers with your existing loan to determine if it makes sense to move forward with a refinance.
When Does it Make Sense to Refinance?
Despite what many homeowners think, even borrowers with fairly new mortgages can benefit from refinancing, especially if that means lowering your interest rate and monthly payment over the life of your loan.
So how do you know if it makes sense to move forward with a refinance? As Investopedia explains, the typical should-I-refinance-my-mortgage rule of thumb is that if you can reduce your current interest rate by 1% or more, it might make sense because of the money you’ll save in interest payments. Whatsmore, by refinancing to a lower interest rate, you’ll be able to build up equity in your home faster, which gives you more buying and future borrowing power.
Another benefit to refinancing is if you’d like to get rid of PMI (Private Mortgage Insurance). Once you’ve reached 20% equity in your home, you have the option to refinance to get rid of the initial PMI you had to take on if you put less than 20% of a down payment on your home. By refinancing, you can keep the equity you’ve built up and reduce your monthly payments by eliminating PMI fees.
When Shouldn’t You Refinance?
If you aren’t able to save money through lower monthly payments or secure a better interest rate, you should probably put off refinancing. Additionally, if you don’t have the cash available to cover the closing costs and fees that come along with refinancing, it may not be the right move for you.
As we mentioned earlier, when refinancing, homeowners should expect to have to fund closing costs, which averages 2 – 5 percent of the loan. This means if you refinance a mortgage for $250,000 with 4% closing costs, you’ll need to front $10,000 at closing to cover fees. And, while some lenders do allow you to roll those closing costs into the principal balance of your new loan, this does increase the total amount that will accrue interest, ultimately costing you more throughout the life of the loan.
As with any financial decision, refinancing your mortgage comes with pros and cons. Before deciding to refinance and take on additional debt, weigh your options carefully, and always consult with a trusted financial advisor or lender to best understand the right move for you and your financial goals.