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Your mortgage terms aren’t forever!
Borrowing money to purchase a home is really a transaction in and of itself. There is an agreement between the borrower and the lender in which the lender agrees to provide money today for more money later. What many people forget is that this agreement can be re-worked down the road for a variety of reasons. This may be something useful to keep in mind even before making the first payment on a new loan. Understanding future options may help some buyers be more comfortable with the choices they have to make today. Comparatively unfavorable terms may be renegotiated later when circumstances have changed. Today’s blog post will focus on some of the reasons borrowers refinance their loans, along with a few tips and pointers for those considering refinancing.
The Basics
Mortgage refinancing is the process of replacing an existing mortgage with a new one. This is done to take advantage of lower interest rates, to reduce monthly payments, or to shorten the term of the loan. We’ve included a few other minor reasons for refinancing below, along with some discussion on the associated costs.
Lower Interest Rates
One of the primary reasons that people refinance their mortgages is to take advantage of lower interest rates. When interest rates drop, it can be a great time to refinance your mortgage. By refinancing at a lower interest rate, you can save money on your monthly payments and reduce the overall amount of interest you pay over the life of the loan.
Lower Monthly Payments
Another benefit of mortgage refinancing is that it can help lower your monthly payments. This can be especially helpful if you’re struggling to make ends meet or if you want to free up some extra cash each month. By refinancing your mortgage, you can extend the term of your loan, which will lower your monthly payments. For example, let’s say you have been making payments on a 30-year loan for 10 years. You can re-finance the remaining balance for a new 30-year mortgage, thereby spreading a smaller principal over a fresh set of 360 payments.
Alternatively, of course, you can refinance at a lower interest rate, which will also lower your monthly payments.
Shorten the Term of Your Loan
If you’re looking to pay off your mortgage faster, refinancing can help you do that. By shortening the term of your loan, you can pay off your mortgage faster and save money on interest. This can be especially beneficial if you’re nearing retirement age and want to pay off your mortgage before you retire. In many cases, however, it may be more practical to get a 30-year loan and simply make higher payments (commonly referred to as overpaying). When overpaying, the money you pay over your required monthly payment is deducted directly from your principal, as opposed to being applied partially to make interest payments. We’ll save the details and examples of this for another blog post!
Convert to a Fixed Rate Mortgage
If you currently have an adjustable rate mortgage, refinancing can help you convert to a fixed rate mortgage. This can be beneficial if you’re worried about interest rates rising in the future. By converting to a fixed rate mortgage, you’ll have the peace of mind of knowing that your interest rate won’t change over the life of the loan. Sometimes, in times where the interest rates are high, but borrowers feel confident that the rates will drop in the near to medium future, an adjustable rate mortgage may be a good idea. When the rates drop, the borrower can “lock in” at a lower rate by refinancing to a fixed rate mortgage.
Cash-Out Refinancing
Cash-out refinancing is another option that’s available to homeowners. With cash-out refinancing, you can refinance your mortgage and take out some of the equity in your home in the form of cash. This can be helpful if you need money for home repairs, to pay off debt, or for other expenses.
Change Lenders
In rare circumstances, a borrower may be dissatisfied enough with the company servicing their loan that changing lenders is sufficient motivation to refinance. At the very least, it could be a factor when combined with the other benefits listed above. Keep in mind, however, that about 60% of mortgages are sold on the secondary market. This means that ultimately you may not have control over who you’ll be dealing with to make your payments anyway.
Why doesn’t every re-finance all the time?
One important element of re-financing to keep in mind is the cost. Like with most things worthwhile, there are associated expenses. Just like the closing costs you paid at the time you purchased the home, your lender will charge you similar fees to refinance your loan. Generally, borrowers can expect to pay between 2% and 5% for closing costs when refinancing. To refinance a loan with $200,000 remaining principal, this calculates to $4,000 to $10,000. Here is a list of potential associated costs:
- Application fee
- Home appraisal
- Origination fees
- Recording fees
- Title Insurance
- Other costs like attorney’s fees, discount points, mortgage insurance, or tax services may also be included
For most borrowers, there comes a “tipping point” where the benefits of refinancing outweigh the upfront costs. Having a good relationship with a lender who is willing and able to provide an accurate estimate of the costs will help borrowers to keep an eye on the numbers and choose the right time to make a move. Using a tool like Karl’s Mortgage Calculator can help home owners understand the impact that a change of terms can have on their monthly payments.
Conclusion
Mortgage refinancing can be a great way to save money on your monthly payments, reduce the overall amount of interest you pay, or pay off your mortgage faster. Whether you’re looking to take advantage of lower interest rates, lower your monthly payments, or convert to a fixed rate mortgage, refinancing can help you achieve your goals. If you’re considering mortgage refinancing, be sure to do your research and compare rates (AND FEES!) from multiple lenders to find the best deal.
Do you have questions about refinancing? We’d love to hear from you!
