Personal Finance

Home Loan Basics: Reasons to Refinance

Jun 20, 2019

Whether it’s been 10 months or 10 years since you purchased your home, you may be thinking about refinancing. This could be due to a sharp decline in interest rates, an email promoting lower monthly payments, or a conversation overheard at the local coffee shop.

Fluctuations in interest rates often drive the decision to refinance, but there are many other reasons you may want to replace your current mortgage with a new one.

A drop in interest rates isn’t the only reason to refinance your mortgage.

Popular Reasons to Refinance

Reasons to refinance an existing mortgage can fall into several categories. Most focus on saving money – either for the short term or an extended period of time. Others involve using a borrower’s equity in a home for another purpose. And another is related to the ownership of the property and who’s responsible for the loan.

Obtaining a Lower Interest Rate

A better interest rate may be the most popular reason to refinance, as it could potentially save you thousands of dollars over the life of the loan.

Securing a lower interest rate could be influenced by more personal factors, such as improvements in your credit score, debt-to-income ratio, financial history, or the current value of your home. Changing loan types may also improve your interest rate.

Decreasing the Monthly Payment

Sometimes the driving force behind a refinance is to achieve a lower monthly payment. This frees up cash to pay off another expense or gain room in an otherwise tight budget. You can meet this goal through a comparable interest rate and a longer loan term.

Shortening the Length of Your Loan

If you want to pay off your loan as quickly as possible, refinancing to a shorter term can help you achieve this goal sooner.

A drop in interest rates could allow you to shave a few years off your loan without a huge jump in the monthly payment. Plus, there’s the added benefit of reduced interest expense over the life of the loan.

If refinancing isn’t an option, a shorter loan period could also be achieved by paying extra each month to reduce the principal balance.

Switching to a Fixed Interest Rate

Adjustable-rate mortgages (ARMs) are a popular product, with common fixed interest rate periods of 3, 5, 7, and 10 years. If you’re like many borrowers, you’ll eventually want to refinance to avoid future rate increases.

When the fixed-rate period comes to an end on their ARM loan, many borrowers are eager to lock in another low fixed rate. This could be in the form of a new ARM product or a fixed-rate loan that offers the same interest rate for the entire life of the loan.

Funding Home Improvements

You can build equity in your home as you make monthly mortgage payments and your home value increases (appreciate). Refinancing your mortgage can often allow you to use some of your equity for home improvement.

To do this, you can replace your existing mortgage with a larger loan, so you can get the cash you need. This typically results in a lower interest rate than what you’d get with a personal loan or paying with a credit card.

Paying Off High-Interest Debt

Home loans typically offer among the lowest interest rates. You can use a cash-out refinance to pay off your higher-interest debt. Aim to keep the new loan less than 80% of your home value. Otherwise, you would likely have to pay the added expense of private mortgage insurance (PMI).

Obtaining Cash for a Specific Purpose

You can also use a cash-out refinance to fund other major expenses. You can use the cash from the refinance for just about any purpose, including college tuition, medical expenses, legal bills, and even a wedding.

Keep in mind that you’re using your home as collateral for these expenses – you’ll want to make sure your new loan payment fits into your monthly budget. You may also want to explore a personal loan for these expenses, especially if you have limited home equity.

Eliminating Private Mortgage Insurance

If your monthly payment includes private mortgage insurance (PMI), you may be able to eliminate this extra expense with a refinance.

With a few exceptions, borrowers pay PMI when they finance more than 80% of their home’s value at the time of purchase.

Over time, your loan-to-value (LTV) may move under 80%, which can allow you to refinance to a new loan and eliminate the extra expense. It’s a great move if you have a FHA loan, which generally doesn’t allow cancellation of PMI, regardless of LTV.

Changing Borrowers

Frequently, mortgages have more than one borrower. If you buy a property with a spouse, parent, child, sibling, other relative, or even a friend, there may be a time when you need to remove the co-borrower or add a new borrower to the loan. The most common way to do this is through a refinance.

Things To Consider When Refinancing

It’s important to weigh the pros and cons of a new loan when you’re thinking about refinancing. Here are areas to explore as you evaluate your options.

Time Since Your Purchase or Last Refinance

How long has it been since you got your loan? Although there is really no limit to the number of times you can refinance your home, many lenders require a minimum amount of time between loans. This varies by lender and product.

A common waiting period is often six months, but it could also be a minimum of four months or even seven months or more.

How Long You Plan to Keep Your Home

Think about how long you plan to keep your home. Savings from a lower interest rate can really add up over the full life of a home loan. But if you plan to sell your home within a year or two, your monthly savings may not be enough to cover the cost of the refinance. Check with your lender for projected costs.

Your Calculated Break-Even Point

What’s the basic break-even point for the new loan? This is the estimated point at which your monthly savings from the refinance cover the costs of the new loan.

For example, if the cost of the refinance is $2,400 and you’ll save $120 a month in interest, the break-even point is 20 months. After 20 months, the cost of the refinance will be covered by the amount you’ve saved each month in interest expenses.

You can use our mortgage refinance calculator to help determine your projected break-even point.

Your Current Credit Score

Your credit score will impact on your interest rate. Generally, the higher your credit score, the lower the interest rate offered. So, if your credit score has risen since your last loan, an improved interest rate may now be available to you.

On the other hand, if your credit report has taken a hit in the last year or so, you may have fewer options for a lower rate. You can get a free annual credit report from each of the credit agencies to review before you apply for a loan.

Your Existing Loan Type

There are many different loan programs available when you refinance. However, your existing loan type may offer a streamlined refinance program that could potentially save you time and money.

For example, the Interest Rate Reduction Refinance Loan (IRRRL) is a streamlined refinance program available for VA-to-VA refinances. For borrowers with FHA loans, there are streamlined programs available for lower interest rates and a cash-out refinance option. These programs offer some unique benefits; however, it’s always good to explore many options before settling on one.

Closing Costs

Like interest rates, closing costs often will influence your refinance decision. They’re often rolled into the new loan amount, but they can also be paid by you directly at time of closing.

The costs can vary widely among lenders. Some lenders offer low interest rates with slightly higher closing costs. Other lenders have reduced closing costs with slightly higher interest rates.

Tailor Your Mortgage Refinance To You

When interest rates decline, you may have an opportunity to save money through a mortgage refinance. However, you don’t need to wait for a major drop in interest rates to explore the benefits of refinancing.

Whether it’s a good time for you to refinance depends on your individual situation and your future plans. Our experienced mortgage team is here at 888-546-2634 to help you explore your refinance options. Want to learn more about the steps involved? Be sure to check out our First-Time Mortgage Refinance Loan Guide.