Benefits of Refinancing a Mortgage (What You Should Know)

Your original mortgage was most likely a great fit when you first bought your house, but that does not mean it will be advantageous for the entire life of the loan. And now you are a seasoned homeowner with more knowledge and experience. Maybe your budget has grown, or you have run the numbers and want to knock those payments out sooner (saving money on interest along the way).

Life changes, and so can your mortgage. Refinancing is a great option that can give your home loan the refresh it needs to fit your current lifestyle and evolving financial goals. In this article, we will detail the top reasons to refinance, what to consider before diving into the process, and your refinance options.

Top Reasons to Consider Refinancing

Every financial situation is different, and as life continues to change, there are reasons why the home loan you have today may not be the best option for you tomorrow. Life can make refinancing your mortgage necessary or can be a means to save you more money in the long run.

Here are eight of the top reasons to consider refinancing your home.

1. Reduce your interest rate

One of the primary reasons people consider refinancing is to lower the interest rate of their home loan. This is why refinances tend to become more popular when market rates are falling.

Generally, a lower interest rate can provide you with a lower monthly mortgage payment and free up money in your budget. Even a small reduction can end up helping you save thousands of dollars in interest over the life of the loan.

2. Switch from an adjustable rate mortgage (ARM) to a fixed-rate mortgage 

An adjustable rate mortgage's interest rate has the ability to change during the life of the loan. This means that when you first get the loan, the rate you are paying is temporary and can go up or down over the life of the loan. The rate at which the ARM changes, whether it is up or down, follows an index and margin rate. For example, if the index rate is 1.3% and the margin rate is three points, you add them together to determine what your interest rate would be for that time period—4.3%.

When does it make sense to switch from an ARM to a fixed rate? 

If rates were low when you obtained your ARM, but rates appear as if they are going to climb or are already beginning to climb, you may want to consider avoiding any potential increase in rates over time. There is uncertainty with an ARM because you do not know how high—or low—rates might actually go. A fixed-rate mortgage is fixed or locked in for the life of the loan. That provides a sense of security knowing you are locked in at your current rate and you can budget your finances accordingly.

3. Use the equity in your home 

This is another popular reason people consider refinancing their home loan. There are two main ways you may have gained equity in your home:

• You have paid down your principal amount. There are a few ways you can pay down principal, which is the amount you owe excluding interest. The first way to reduce the principal is to continue making your monthly payments over time. The second way is to make additional payments and apply them to the principal, as opposed to making a prepayment.

• Your home value increased. In some areas of the country, home values have been rapidly increasing. For example, in California, home values have soared over the last few decades. When you apply for refinancing, your home is appraised for its current value. If home values have increased, you have more equity in your home to pull from.

There are many ways in which you can use the equity in your home: building an addition, putting in a pool or outdoor kitchen, or remodeling parts of your home. You can even use the funds to pay off high-interest debts or education expenses.

4. Consolidate debt

Another reason why many people consider refinancing is to consolidate debt. That debt may come in the form of student loans or high-interest credit cards you would like to pay off. Overall, home loan interest rates are typically lower than other types of interest rates. Therefore, you can leverage equity in your home to consolidate your debt and reduce your total monthly expenses.

However, it is important to understand the costs of refinancing and take those into consideration when calculating the advantages of debt consolidation.

5. Reduce the term of your loan

As interest rates change, some homeowners look to a lower interest rate as an opportunity to reduce the term (or length) of their home loan. For example, if interest rates have recently lowered, or perhaps your financial situation has improved, you might want to lower the term of your home loan to save money over time and pay off the loan more quickly.

In the chart below, you can see how much you could save over the life of a $300,000 loan with four different terms. For simplicity, all options have an interest rate of 5.50%.

Loan Term	Total Paid in Interest	Total Cost (Principal & Interest)
30 years	$313,212	$613,212
20 years	$195,279	$495,279
15 years	$141,225	$441,225
10 years	$90,695	$390,695

 

As you can see, the shorter terms lead to less interest and a lower overall cost of the loan. With the 30-year option, the amount you pay in interest is actually more than the amount of the original loan.

6. Eliminate mortgage insurance

If you have a Department of Veterans Affairs (VA) loan, you do not have to pay for mortgage insurance. If you have an FHA loan or did not have enough for a 20% down payment, it is likely you have some type of mortgage insurance, whether it is private mortgage insurance (PMI) or mortgage insurance premium (MIP). (Note that when it comes to FHA loans, even if you are able to put down 20% at closing, you will still have MIP.)

If you have an FHA loan and built up more than 20% equity based on the current appraisal of your home, you can use refinancing as a tool to eliminate that monthly mortgage insurance fee.

It is worth noting that it is possible to eliminate PMI on a conventional loan without the use of a refinance once you have built enough equity. Some lenders may even remove it automatically when you have reached 20% equity, so be sure to consult with your lender to learn more about your options.

7. Consolidate two mortgages into one

If you have two mortgages, refinancing can consolidate both into one—assuming you meet the criteria necessary with equity, value, credit, and more. The advantage to consolidating is that a second mortgage typically has a higher rate than your first mortgage. Consolidation can reduce your overall mortgage payment.

8. Your financial situation has changed 

If your financial situation has changed over time, you might want to consider refinancing to either reduce your monthly payment, lower your term, reduce mortgage insurance, or for some other reason. Refinancing can be beneficial if your financial situation has improved or even if it has become more challenging.

Is Refinancing Right for You?

Before you decide whether or not a refinance is the right financial move for you, it is important to determine if the potential costs outweigh the benefits of refinancing. Here are some things to consider before you dive into the refinancing process.

Financial considerations

A refinance replaces your current mortgage with a new one. That means paying closing costs to cover services and fees throughout the process. You can expect to pay between 2% and 6% of the loan for closing costs. Here are a few costs and fees you can expect to encounter:

• Appraisal fees

• Title fees—administrative expenses associated with documenting ownership of the property

• Attorney fees (if necessary)

• Recording fees

• Points—if you want to reduce the interest rate even further you can pay points during a purchase, where one point represents 1% of the total loan amount

These costs add up, and the biggest financial aspect you should consider before refinancing is what your break-even point will be. This is the point at which the savings from refinancing and the initial costs are equal.

Life situation factors

Even when the financial benefit of a refinance is tempting enough to warrant exploring your options, it is vital to consider if it fits with your lifestyle and personal goals. For example, if you do not plan on living in the home much longer or at least long enough to reach the break-even point, then refinancing may cost you more than it saves you. The longer you plan to live in your current home, the more a refinance may benefit you.

Remember, you are paying up-front closing costs (and possibly increasing your monthly payments if your goal is to pay off the home loan sooner) in order to save money down the road. That sacrifice may not make sense if there is a high likelihood you will be moving in the next few years.

Exploring your refinance options

There are many different reasons to consider a refinance, and there are also a few different refinancing options available. In general, most refinancing can be categorized into these types:

• Rate and Term Refinance. Allows you to adjust your interest rate, change your loan term (length of the loan and type), or both. For example, you could change from a 5-year ARM to a 30-year fixed-rate mortgage with a lower interest rate.

• Cash-Out Refinance. A cash-out refinance allows you to take advantage of the equity in your home and refinance to a lower interest rate while taking out cash to use for different purposes.

• Interest Rate Reduction Refinance Loan (IRRRL). An IRRRL is intended for reducing the interest rate on a VA loan through a lower rate VA loan.

As you walk through your needs, goals for refinancing, credit score, and more, you can work with a loan expert to determine if refinancing your mortgage is right for you. If the cons outweigh the pros, refinancing may not make sense for you right now.

While making your calculations, you will need to determine if you are refinancing to reduce your monthly payment or to extend the term of your loan. If you refinance and get a lower rate, are you adding years to your payments? There may be a reason to do so, but it is important to understand the overall initial costs versus potential total savings over time. Be sure to reach out to your lender to better understand your options.