Perhaps you’ve improved your credit scores since your first loan, or just feel like you can get a better deal through refinancing.
But is it really the best decision for your finances?
When done for the right reasons, mortgage refinancing can save you money—or at the very least, decrease your payments. Otherwise, it can be a costly mistake. Before you begin gathering your bank statements and pay stubs, think carefully about your reasons to refinance.
So, when is refinancing good or bad?
When is Refinancing a Good Idea?
To find out whether you need to refinance, you need to weigh the advantages and disadvantages of your old loan against your refinancing options.
Generally, it’s advisable to refinance if such a move will help you:
- Save money through smaller payments or lower interest rates
- Optimally restructure your debt, or
- Shorten the term of your mortgage loan.
In addition to these considerations, you also need to factor in the costs of refinancing. With these in mind, evaluate your potential savings over time. When is your breakeven point? Also, consider the amount of time it’ll take you to recover any up-front costs related to the refinancing option.
How long do you plan on keeping the loan or living in the home? Is that period long enough to make refinancing worthwhile?
One way to address these questions is by performing a break-even analysis. And while it’ll help you determine when you’ll come out ahead, there’s still more to think of.
What are the Best Reasons to Refinance?
Mortgage refinancing works best if there are valid reasons for such a move. Here are 10 such reasons:
To Capitalize on a Lower Interest Rate and Payment
It’s always wise to refinance your mortgage if the refinancing option’s interest rates will save you money. The things to look out for here are the monthly mortgage payments, and the accrued interest you’ll have paid at the end of the loan’s life.
But don’t just focus on rates and fees. Try to look at the structure of the loan. You’ll save much more if you can optimally structure your loan and create a lock plan. The lock plan will help you determine when to lock, for how long, and at what rate.
It’s advisable that you find your “target rate”. To do this, begin by determining your “regret rate”. This is the rate at which you’d be furious for missing out. This will help you avoid the common pitfall of asking for the “best rate”. Often the “best rate” is impossible to define, and this introduces an element of vagueness.
Also, it’s important to obtain rates from different refinancing lenders, brokers are a great option here since they will shop the loan with multiple banks, for you. Not only will this allow you to choose the best option, but also provide you with enough leverage when negotiating the terms of your debt.
To Get Rid of Mortgage Insurance
If your current home loan has private mortgage insurance, refinancing can help you cut down on monthly costs. This is especially true for people whose loans are insured by the Federal Housing Administration (FHA).
While FHA mortgage loans come in handy for borrowers with bad credit or little savings, they come with a big drawback: compulsory mortgage insurance.
After the upfront premium payment of 1.75% of the total loan amount, most homeowners using FHA loans keep paying a non-cancellable annual insurance premium. This can be up to 0.85% of the loan total, and they pay it for the remainder of the loan term.
Such payments add up over time and increase your debt in the long run. That’s why refinancing to get rid of private mortgage insurance is highly advisable. It allows you to convert your FHA loan into a normal mortgage once you have at least 15% equity in your home.
To Consolidate High-Interest Debt
If you’re stuck with a large high-interest debt on other loans or credit cards, a cash-out refinancing option might provide a way out. Not only will it boost your cash flow, but also save you a significant amount of money in the long run.
The only drawback here is that you won’t be able to deduct the mortgage interest you'll be charged on the cash-out amount that's in excess of the current loan balance. Property tax laws only allow you to do so if you use the funds to build, buy, or significantly improve your home.
But despite the loss of some mortgage interest deductibility, cash-out refinancing is still beneficial in the long run. It’ll improve your cash-flow situation, result in monetary savings, and get you out of debt quicker.
To Take Advantage of a Better Borrowing Profile
So you’ve bettered your FICO scores and cleared up some of the negative stuff. Or maybe you’ve grown your home’s value enough to get your loan to value ratios (LTV) to a lower tier. Whatever the case, an improved borrowing profile qualifies you for a lower interest rate.
In such a case, it would be wise to refinance so you can save money on your monthly payments.
To Cut Down the Loan Term
Say you came across a huge amount of money and want to aggressively pay down your mortgage debt. In such a case, you’ll benefit from refinancing to a shorter-term loan. For instance, if your existing mortgage had a 30-year term, you can refinance to a 15-year fixed one. Or any 1 year increments. Like a 27yr mortgage instead of a new 30yr, while keeping the payments the same.
Mortgages with shorter terms also have lower interest rates, meaning you’ll save a lot by paying off your mortgage faster.
To Switch to a Fixed Interest Rate
When interest rates drop, it might be a good idea to switch from an adjustable rate mortgage (ARM) to a fixed rate loan. That said, you should keep in mind that the interest might be slightly higher in fixed-rate property loans compared to adjustable rate mortgages.
However, the predictability of fixed payments can be worthwhile if you value stability. A fixed rate provides valuable stability, especially when you’re dealing with many unpredictable life expenses.
To Extend the Loan Term
While it might make sense for some people to refinance with the aim of cutting down their loan term, others might want to extend their term. For the latter, the interest expense will be much higher, but they’ll enjoy less monthly payments.
If you’re unable to comfortably pay your current mortgage loan within the agreed term, refinancing can be a smart way to extend that period. And while it’ll cost you more interest, reducing your monthly payments might be a more sustainable option. That’s especially true when your level of income isn’t exactly where you expected it to be when you secured your current mortgage.
To Switch to an Adjustable Rate Mortgage
Sometimes, studying real estate market trends can reveal lower interest rates, which present a good opportunity to switch to an adjustable rate mortgage. A refinance can help you exercise your right to take out an adjustable rate mortgage and vice versa.
But when switching to adjustable rate mortgages, keep in mind that their rates only hold steady for a few years, after which they start varying. Such loans often start out with rates lower than those of fixed-rate mortgages. After a while, they can adjust downwards when the market rates start to fall.
But since adjustable ARMs always come with the risk of the rate eventually going higher, you could find yourself refinancing your way back to a fixed rate loan in future.
To Remove or Add a Name to the Mortgage
If you marry, get divorced, or need to change the names on your mortgage for any other reason, refinancing can be a viable way to do that. It’ll create a brand new mortgage, with only the names you want on it.
You can also use refinancing to release a co-signer from your mortgage deal. Lenders often allow this when the financial situation of the borrower improves significantly over time.
To Merge Two Mortgages
Some homeowners have two separate mortgages. Others have a home equity line of credit and a mortgage. Whichever the case, two mortgages call for two separate payments each month, and some people might find this needlessly complex.
If this is your case, you can use refinancing to combine both debts into one mortgage. And while this could mandate the purchase of mortgage insurance, the interest savings can be significant enough to offset the insurance costs. This, of course, depends on the terms of both of your mortgages.
How Many Times Can You Refinance Your Home?
If you’ve been wondering “when is refinancing bad or good?” we hope that our guide has answered some of your questions. With so many reasons to refinance, you’re probably wondering how many times you can exercise that option.
In a nutshell, there’s no limit. That said, you need to be eligible for refinancing. Also, you might have to wait for about half a year to refinance in case of a new home purchase. But with so many risks involved in refinancing, you’ll need a mortgage expert to guide you.
Here at SMB, we specialize in helping home buyers secure great real estate financing terms. We also provide guidance to help you make the right decisions when buying a home in Washington.