A mortgage refinance involves paying off a current mortgage loan and replacing it with a new one. Refinancing often results in better terms, which can save you thousands over the life of your loan.
But while refinancing is common practice, many homeowners question whether they should go through with the process. Refinancing comes with a new set of closing costs and you have to apply for a new mortgage, so it's a decision that shouldn't be taken lightly. In the end, you have to decide whether now’s the right time.
To help you make a decision, here are seven reasons why some people consider refinancing.
Lower Mortgage Payments
If average rates are lower than what you're currently paying on your mortgage loan, refinancing is one way to get an interest rate reduction. Since interest rates have a direct impact on how much you pay each month, getting a lower rate can also lower monthly payments. This creates more cash flow in your budget. You can use the extra cash to pay down debt, build a savings account or reach other financial goals.
Escape an Adjustable-Rate Mortgage
An adjustable-rate mortgage is a type of mortgage in which the interest rate changes. These loans have an initial fixed-rate period of three, five or seven years. After the fixed-rate period, the rate changes every year to reflect market changes. The mortgage rate can increase or decrease, which causes monthly payments to rise or fall.
Adjustable-rate mortgages are attractive because they often feature lower rates in the early years. But once rate adjustments kick in, some borrowers are uncomfortable with the possibility of their mortgage payments increasing. Refinancing lets these borrowers convert their ARM to a fixed-rate, where they can enjoy predictable payments.
Cash-Out Your Equity
Home equity is the difference between your home’s value and what you owe the mortgage lender. Typically, you would have to sell the home to get your hands on this cash. If you don’t have any plans of selling, a cash-out refinance is another option.
This type of refinancing lets you borrow cash from your equity—up to 80%. Cashing out your equity means you’ll owe more on your house and you’ll have less equity. However, it’s an option if you need cash for debt consolidation, home improvements, college expenses or any other large expense.
You Have the Credit to Qualify
Some homeowners think qualifying for a refinance is a walk in the park, primarily because they already have a mortgage loan. What they fail to realize is that refinancing creates an entirely new mortgage loan, which is completely separate from their previous mortgage. It involves a reevaluation of their credit and income.
If you’ve kept your credit score in pretty good shape since getting the original mortgage, and if you have enough income, qualifying for a refinance shouldn’t be a problem. But you could run into problems if you’ve experienced credit problems in recent years, or if your income has changed significantly due to a job loss, retirement or other reasons.
You’re Getting a Divorce
If you’re getting a divorce, you and your spouse can sell the house, take your halves of the equity and go your separate ways. But in the event that your ex-spouse chooses to keep the house (or vice versa), refinancing is the only way to remove your name from a joint mortgage loan. Your ex will have to apply for a mortgage in his name, and he’ll need enough income and a high enough credit score to qualify for the mortgage on his own.
You're not required to refinance – but as long as your name remains on the mortgage, you’re responsible for the balance. It doesn’t matter if you sign over the mortgage deed or if your ex promises to make timely payments. If he defaults and stops paying the mortgage, this will damage your credit score.
You’re Not Planning to Sell
Before refinancing, consider how long you plan to live in the house. Refinancing can lower your mortgage and save you money, but it has to make sense from a financial standpoint. Since there are costs, you need to live in the house long enough to recoup what you pay in closing. To calculate your breakeven point, divide the amount of the closing costs by your monthly savings. For example, if refinancing results in a monthly savings of $200 and you paid $5,000 in closing, you’ll need to live in the home for at least another 25 months to breakeven.