If the value of your home has increased, or if interest rates have dropped, you may want to consider refinancing your mortgage loan.
There are many good reasons to consider refinancing; however, doing so is not always the best option for every homeowner.
What is mortgage refinancing and is it a good idea?
Refinancing is the process of getting a new loan to pay off an existing mortgage.
There are many good reasons to consider refinancing, but it’s important to review your current financial situation and fully understand your options as a homeowner.
Step 1: Understanding home equity
Are current rates lower than the rate you got on your mortgage loan? Are you a homeowner who’s lived in your home for a number of years?
If so, it’s time to talk about home equity.
What is home equity?
Simply put, it’s the amount of your home that you own.
To figure out how much equity you have, subtract your mortgage loan balance from your home’s current market value. The difference is the amount of equity you have.
There are two ways you can get equity in your home.
- Home appreciation – the value of your property goes up from your purchase price.
- Paying upon your loan – you’ve made payments to the principal of your loan.
Both may happen at the same time— meaning, as you pay down your mortgage, your home’s value may rise because of home updates, renovations and market trends.
Why is home equity important?
Owning a home and getting home equity is a no brainer for many investors.
When you own a home, the money you pay each month goes towards an investment. If you were renting, that money would be 100% lost and gone; however, because you’re a homeowner, it’s not.
It’s now accumulating as equity.
If your home grows in value, home appreciation is much like getting a return on an investment. If you were to then sell, that would be more money in your pocket after you closed. But, as you’ll soon see, there are other ways to use it.
How can you use home equity?
You can use home equity in a variety of ways.
One popular method is to do a cash-out refinance.
With a cash-out refi you get a new rate, a new loan, and whatever equity you’ve accrued in your home is cashed out.
We talk more about cash-out refinance later in this guide, you can skip to that section by clicking here.
Another option would be to do a rate and term refinance.
A rate and term refinance is best done when rates have decreased or your personal finances have improved. With this option, you can opt to either decrease your monthly payments or shorten the repayment period.
Check out our Refinance Calculator to see how accessing your home’s equity would affect your monthly mortgage payment.
Step 2: Knowing when I should consider refinancing?
Even if you are happy with the terms of your mortgage and your monthly payment, refinancing can still be hugely beneficial, either by shortening your loan duration, lowering your monthly payments, or doing both at the same time.
Take Advantage Of Changes In The Market
Every time the current mortgage rate drops, you have an opportunity to save money by paying less interest.
Even small changes can add up considerably over the lifetime of a loan. Today’s homeowners can save themselves an average of 30% by refinancing at a lower rate – a saving that can more than make up for a few additional years of interest if you refinance out to 30 years.
Faster Loan Pay Off
The shorter your loan term, the less you’ll pay in interest making your loan more affordable over the life of the loan.
For example, if interest rates have decreased while the value of your home has increased, you may be able to refinance your mortgage to a shorter loan term. By going from a 30-year-fixed loan to a 15-year-fixed loan, you’ll be able to pay off your mortgage loan sooner. Plus, you’ll be able to pay less interest at a lower interest rate.
Or, you get your monthly payment lowered from $2,500 to $2,000. If you continue to pay $2,500 every month – something that is already in your budget – then you shorten the life of your loan by paying it off more quickly. This allows you to reap the benefits of both lower interest and a shorter loan – saving money on two fronts.
You may be able to access cash to pay off high interest debt, allowing you to make one low monthly payment and pay less interest over the life of the loan.
As interest rates on home loans are typically lower than those associated with credit accounts, debt consolidation through a refinance can often help pay down debt faster, at a rate that may also lower your total monthly payment.
Lower Your Payments
If your current loan is at a rate above currently available rates, a refinance has the potential to help you maximize your monthly income and save money over the life of the loan (you’ll pay less total interest).
Change your home loan type
If you have an adjustable-rate mortgage (ARM), a balloon loan, or if your loan payment includes Private Mortgage Insurance (PMI), you may want to consider refinancing to a fixed-rate mortgage.
Free up cash
You can borrow against your home equity through a loan or a line of credit. Doing so can free up funds to use for a variety of needs, such as debt consolidation, home remodeling projects, and/or major purchases.
There are many life events that can cause your financial situation to change, such as a change in income, a family death, or the birth of a child. Some common financial changes that may require refinancing include:
Removing a Co-Signer
If someone co-signed on your loan when you bought your home to help you qualify, you will probably need to refinance to remove them from the loan.
To release them from their obligation of liability (for instance, if they are looking to purchase their own home), a refinance will remove this co-signer from your loan.
Buying out a Co-borrower or Spouse
If you were married when you bought your home but have decided to divorce, a refinance is required if the house is awarded to one of the partners by the divorce decree.
This refinance will remove the non-interested party from the loan and the title. If your divorce decree requires you to buy-out your former partner’s interest in the property for a determined amount, you can refinance to remove them from the mortgage loan and pay to buy-out their interest.
Step 3: Mortgage refinancing considerations
Before making the decision to refinance, consider these factors:
You may need to stay in your home for a certain number of years to reap the greatest potential savings of refinancing.
Your current mortgage terms might include a prepayment. Read your mortgage documents carefully.
Your income tax could be affected by a mortgage. Consult your tax adviser about any possible tax implications.
You could be responsible for paying certain fees associated with refinancing your mortgage. These fees might include, but are not limited to, application, recording, title, mortgage tax settlement, tax services, and processing fees.
Tip: Get Your Lender to Pay Your Closing Costs
The most attractive potential part of refinancing a home mortgage is what is called a no-cost loan. With these kinds of loans, there are no closing costs associated.
The lender may cover the closing costs in exchange for slightly higher interest.
While the interest does add up over the lifetime of the loan, you can prevent it from becoming too much by taking advantage of the other strategies for saving money such as early repayment or a shorter mortgage term. Meanwhile, you have no out-of-pocket costs to worry about recouping with the savings from your lower interest rate.
Step 4: Understanding cash-out refinancing
Cash out refinancing is a type of refinancing where you exchange your current home loan for a new one but any home equity you have is swapped out for cash.
Your new loan would be the sum of your old mortgage plus the amount of equity you cashed out.
Most homes appreciate over time, so many homeowners have more equity in their home than they are aware.
A good gauge of your home’s value is to look at your tax assessment to get a ballpark, but your bank will do an appraisal to assess your home’s current value once you begin the refinance process.
How to Do a Cash-Out Refinance
In order to do a cash-out refinance you need to have some equity built up in your home. Whatever equity you have in your home is what you’re borrowing money against.
Say your initial mortgage was for $200,000, but your home is now worth $300,000. The remaining $100,000 is the amount you could cash-out. If you did cash-out all of it, your new mortgage would be for $300,000, but you’d have $100,000 in the bank to use as you see fit.
Applying for a refinance is very much the same as applying for a mortgage, so you’ll need to have copies of paystubs, tax returns, as well as copies of any asset statements you have.
When It’s a Good Idea
There are certain scenarios where a cash-out refinance is definitely a good idea, but each of them revolve around putting you in a stronger financial position. See below:
Pay Off High Interest Debt
If you have a lot of high interest debt, such as credit cards, auto loans, or student loans that are eating up your monthly cash, then, depending on certain factors, cashing out the equity you’ve developed in your home to pay them off would make sense— as long as your monthly DTI lowers, of course!
Continue Your Education
Any kind of professional development that could increase your salary would be a wise use for the cash from a cash-out refinance— especially if the potential new income would far outweigh the increase in monthly mortgage payments.
Upgrade or Repair Your Home
If you need a larger home but don’t want to go through the whole home buying experience again, a cash-out refinance could get you the ideal home without requiring you to uproot your family and take on more debt.
Or, if you need to sell your home but know you need to make some improvements, such as replacing the roof or upgrading the home’s plumbing, then a cash-out refinance could quickly get you the cash you need to make your home more sellable.
Get a Better Rate
If rates have significantly lowered since you initially bought your home or your credit score has improved, it’s quite possible you could lower your monthly mortgage and boost your savings at the same time with a cash-out refinance.