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Refinancing is, simply said, that you get a brand new loan and get rid of the old one. The most common reason to refinance is, of course, to take advantage of lower interest rates and thereby save on mortgage costs. However, there might be other goals you want to accomplish by refinancing.
You might have more than one reason to refinance, but defining your goals will help you find the right mortgage for you because each goal will affect the kind of loan and terms you’ll face. If you plan carefully, you may be able to accomplish multiple goals.
Here are the common goals people want to accomplish when they refinance their mortgages. Read through the refinance goals below to see if any apply to you.
Reduce monthly payment
Who doesn’t want a lower monthly payment? Here are the ways you can reduce monthly payments.
- Replace your present mortgage with a new one that offers a lower interest rate
- Switch from a fixed rate to an ARM
- Stretch out the mortgage term
Note: When you are considering refinancing, do not simply focus on the monthly payment only. While refinancing reduces your monthly payment, it often stretches out the term of your loan, which can dramatically increase your total cost. Besides, the heaviest interest charges are at the start of the loan, and beginning a new loan means making those high interest payments all over again. A far wiser move is to use the lower interest rate to shorten the life of the loan and dramatically reduce the amount of interest paid.
Cut total costs
Repaying your mortgage goes basically toward paying the principal you borrowed and interests on the principal. The biggest savings, as you’d expect, come from paying less interest. You may be able to reduce the total interest costs by following:
- Replace your present mortgage with a new one that offers a lower interest rate
- Switch from a fixed rate to an ARM or vice versa
- Get a shorter term loan
Note: You can reduce interest costs significantly by shortening your loan term, but it will probably increase your monthly payment and strain your cash flow.
Pay off your loan faster
You could pay off your mortgage more quickly by replacing your loan with one that has a shorter amortization term (i.e. switching from a 30-year loan to a 15-year loan). This would increase your monthly payments, but allows you to pay off the loan earlier and reduce your total costs significantly.
Note: If all you want is to pay the loan off quicker, you can make an additional principal reduction payment each month that will achieve the same result without refinancing. Besides, you might choose to put that extra money to productive use such as contributing to retirement accounts or investing on stocks or mutual funds rather than paying down your mortgage faster.
Change loan type
You might want to change your loan type to better fit your financial situation.
- Adjustable rate to a fixed-rate: If mortgage interest rates are low and you are currently having an ARM, you might want to lock into the low rate by changing your ARM to a fixed rate mortgage. With a fixed rate mortgage, you will have no worry or anxiety over possible changes in your monthly payment, and budgeting and planning the rest of your personal finance will be easier.
- Fixed rate to an adjustable rate: If you are not planning to hold your loan for a long time and/or willing to take the risk of possible increase in your monthly payment, you might want to save money by refinancing to an adjustable rate, which offers a lower initial interest rate.
Obtain cash
When faced with a significant expense, such as medical costs, a new addition to your house, or a child’s college education, you may find that you don’t have the necessary cash on hand. In such a situation, you can refinance with a new mortgage that is larger than your remaining balance (a cash-out refinance).
Note: In many cases, cashing-out means that you’ll have a larger mortgage balance than before, with possibly a higher monthly payment — and you’ll have to qualify for that new mortgage. If freeing up cash in your home is what you’d like to do, it might be wiser to consider a home-equity loan or a line-of-credit instead.
Debt Consolidation
There might be times you must replace an existing mortgage with new financing even if it won’t save you at all, such as when you have a short-term balloon loan coming due soon. Even though consolidating is not the prim reason why you refinance, you might want to roll your other debts such as credit card balances or auto loans into your new mortgage when you refinance. It is because mortgage interest rates are much lower than other loans and the interest on your mortgage is usually tax-deductible.
Note: If you have a spending problem, you are turning what should be short-term debt into long-term debt, which can cost you more in the long run. You are also putting your home at greater risk should your financial situation get worse. Invest the time to look at your spending habits and lifestyle before you consider refinancing.