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Many homeowners choose to refinance their mortgages for a multitude of different reasons. Whether you’re looking to tap into the equity you have accrued on your property, you’re hoping to secure a better interest rate, or you want to adjust the term of your agreement; there are many good reasons to refinance.
However, refinancing your mortgage can also come with some risks and costs and there is a range of important factors to be considered. Here, we’ve compiled all of the information you’ll need when assessing whether or not refinancing is a viable option for you, and how to evaluate the potential risks and the possible benefits.
Let’s start by looking at why you might be looking into refinancing…
Common Reasons for Refinancing
Listed below are some of the most common reasons for refinancing a mortgage agreement. Your reasons for refinancing might fall into one of these categories, or you might have more than one reason for looking into refinancing.
Whatever your reasoning is, it’s important that you go into this with all of the facts and a good awareness of the potential benefits and risks of doing so. It’s also good to have a clear idea of what you are hoping to gain from refinancing your mortgage.
1. You Want to Cash Out Some of the Equity You Have in Your Home
Depending on the length of time you’ve had your current mortgage and the number of payments you’ve already made, you might have a substantial amount of equity in your home. This equity can be accessed in a cash-out refinance. Many people choose to do this to cover costs such as college fees or home renovations. This might also be a good option if you’re looking to pay off some short-term debts or to maximize the amount you’re able to save and the interest you could obtain on your pension.
By doing this, you’re likely to increase the term of your mortgage or increase your monthly payments, but this can be an acceptable option since mortgage agreements tend to have significantly lower interest rates than other debts with shorter-terms. But there are a number of things to consider here, which we will cover in the following sections.
2. You Want a Better Interest Rate
Your current mortgage might have a high interest rate (or higher than current mortgage rates), in which case it is a good idea to look into refinancing and securing lower rates. Mortgage interest rates fluctuate constantly depending on the current economic situation. Things like inflation, economic growth, and employment rates all contribute to the rising and falling interest rates.
If you’re able to refinance at a time where interest rates are low or falling, you might save yourself a substantial sum of money in the long run.
It’s a good idea to check the current mortgage rates every now and then to see how they compare to your rate.
3. You Want to Change from an ARM to a Fixed Rate
As we previously mentioned, interest rates are extremely changeable, which is why most people opt for fixed-rate mortgage agreements, rather than an adjustable rate mortgage (ARM).
Adjustable rate mortgages can end up costing significantly more than a fixed-rate term purely because there is no guarantee that your interest rates will remain the same from one year to the next. You might start out with great interest rates but these could increase drastically over time.
For this reason, it’s usually a good idea to look for a fixed-rate mortgage and refinancing might enable you to secure one.
4. You Want to Change the Term of Your Mortgage
Some people choose to refinance their mortgage in order to increase the term of the agreement. This is helpful if you’re having trouble meeting your monthly payments and want to reduce these to better fit your current financial situation, but it will put you further away from being mortgage-free. This is likely to increase your interest rates slightly, but it can allow you to free up some extra cash for saving or covering other expenses.
Others refinance to shorten the term of their mortgage. Often, this means lower interest rates and you could end up owning your home much sooner. You’re also likely to see an increase in your monthly payments, so make sure you have accounted for this before refinancing.
5. Debt Consolidation
This one is similar to the cash out refinance except that instead of using the money for home improvement, education, a wedding, or something else, you’ll be using the equity in your home to pay off other debt.
Typically, mortgage rates are much lower than credit card interest rates and other types of debt (like personal loans or car loans). As a result, you can see significant relief in terms of the monthly payment by refinancing and consolidating debt. However, there are a few very important factors that you need to consider.
- Your replacing non-secured debt with debt that is secured by your home. If you’re not able to make your credit card payments it will damage your credit score but you’re not in danger of losing your home. Once you put that debt into a mortgage, you run the risk of losing your home if you can’t make the payments in the future.
- You’re stretching out the loans. Most debt consolidation refinances are for a 30-year term, because a 30-year loan will provide a lower monthly payment than a 10, 15, or 20-year loan. The debt that you’re consolidating is now going to take 30 years to pay off. If you use this refinance to pay off a car loan, you’re going to be paying on that car for 30 years instead of just a few years.
- It’s only beneficial if you avoid more debt in the future. A lot of people who use a refinance to consolidate debt wind up with more credit card debt or other types of debt in the future. In this case, they’re in a worse situation than they were before the refinance.
Debt consolidation refinances can make sense in some situations, but they’re a bad idea more often than not.
Is Refinancing The Right Option for You?
So now that you know exactly why you’re looking into refinancing and what you hope to gain from this, it’s time to consider whether this is in fact a good option for you. This is a huge decision and will undoubtedly have significant effects on your overall financial situation.
Here are some of the best ways to evaluate whether or not refinancing is a good choice for you.
Assess Your Finances
Before refinancing your mortgage, it’s absolutely vital that you have a good understanding of your overall financial situation. You need to be sure that you can afford your new monthly payments and you can adhere to the new terms of your mortgage.
If your finances are looking good, refinancing might be an excellent option for you. However, if you have an inconsistent income or the refinancing is likely to impose extreme financial difficulty on you, it’s probably not the best option right now.
Use a Refinancing Calculator
There are a number of online refinancing calculators which can be accessed for free and enable you to determine the financial implications of refinancing your mortgage.
You’ll need to input information such as your regular salary, any existing debts and monthly payments, as well as details regarding your current mortgage agreement. The calculator will then give you a basic overview of the likely impacts of making changes to your mortgage.
These offer a good starting point when looking into refinancing and establishing whether it’s a realistic option.
Seek Professional Advice
The final step in assessing whether this is a good choice for you might involve seeking professional advice from a financial advisor.
These professionals are likely to have the best advice when it comes to current interest rates and mortgage terms. They will assess your entire financial situation and will then provide you with the best refinancing options to fit your needs.
Important Factors to Consider When Refinancing
Now we’ve covered the basics, let’s take a look at some important factors to consider before going ahead with refinancing your mortgage. It is vital that these things are considered before signing a new agreement.
Refinancing involves various costs and there are several factors that can impact the positive and negative implications of your refinancing. If you are working with a mortgage or financial advisor, it’s likely that they will take care of these things for you, but if you’re managing the refinancing independently, you’ll need to be aware of each of these factors.
Your Future Plans
How long do you plan to live in the home? In order to offset the costs of refinancing, you’ll need to stay in the house for at least a few years or you’re likely to wind up paying more in fees than you save from the refinance. Ideally, you should be planning to stay in the home for a long time if you decide to refinance.
Keep in mind that the fees for the refinance will increase the total balance owed on the mortgage (unless you pay the fees out of pocket, which most people don’t do). When you want to sell your house, you’ll also have the seller closing costs to cover, so if you wind up selling the home in the near future it’s possible that you could owe more than the home is worth after considering the higher mortgage balance and the closing costs to sell.
Your Credit Score
When thinking about refinancing, you’ll want to keep a close eye on your credit score. Having a high credit score will enable you to secure the best interest rates and mortgage terms. If your current credit score is significantly higher than it was when you took out your current mortgage agreement, you might qualify for a much better agreement now.
It’s a good idea to take steps to improve your credit score before going ahead with refinancing. There are a multitude of apps and websites that will advise you on how to improve your credit rating.
Current Interest Rates
Similarly, it’s important to regularly check in on the current mortgage interest rates. As we stated earlier, interest rates are highly changeable and fluctuate regularly. If possible, it’s always best to refinance at a time when interest rates are low or are falling.
Refinancing your mortgage will come with closing costs. These include the application to refinance as well as an updated home appraisal and inspection and fees to cover the lender’s attorney review and origination fees and points.
On average, refinancing costs range from 3% to 6% of the overall loan amount. This can end up being a substantial amount of money, so it’s important to evaluate whether the costs are worth the potential benefits of refinancing.
So, refinancing your mortgage could prove extremely beneficial. It might result in you having more money to save for your pension, to pay off existing debts, or to carry out home renovations. It might also mean you’re able to secure lower interest rates or a more suitable term length on your mortgage.
While there are a number of potential benefits, it is absolutely vital that you consider all of the possible risks and the costs that you might incur by refinancing. There are also many factors to consider and be aware of to ensure that you secure the best mortgage deal and don’t damage your financial wellbeing.
Should you decide refinancing is the right option for you, be sure to consider each of the points listed above and you should be fully equipped to make well-informed decisions when it comes to refinancing your mortgage.