Refinancing a mortgage means you pay off the current or existing mortgage and replace it with a new one. If you’ve owned your home for several years, you may be considering refinancing as an option. But how do you know you should refinance? And why do you refinance instead of keeping the original loan? In this post, we will break down the reasons you might consider refinancing.
So why refinance? Refinancing your home can offer several benefits including securing a lower interest rate, shorten the loan term, or converting from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage.
In the past, most lenders recommended refinancing only if you were able to secure an interest rate 2% lower than the current interest rate. However, lenders now say that even 1% lower is sufficient when refinancing. Talk with your preferred lender about your options. If lowering your interest rate isn’t a possibility, it’s best to stick with your existing loan.
Converting from an ARM to a fixed-rate mortgage can also be a benefit to refinancing. But first, what is the difference between adjustable and fixed rate mortgages? With an ARM, the interest rate is periodically adjusted based on an index which reflects the cost to the lender of borrowing on the credit markets. Which means your interest can increase over time, versus a fixed-rate mortgage with interest rates that are “fixed” or stay the same. With a fixed-rate loan, you are able to avoid interest rate hikes that may occur due to market changes. Conversely, if you have a fixed-rate mortgage, converting to an ARM when interest rates are falling can land you an interest rate that’s lower than your initial fixed-rate. If you plan on staying in a home for a long period of time, or it’s your “forever home”, you want to consider obtaining a fixed-rate mortgage. If you’re in a starter home, or know you will sell in a few years, it’s generally best to stick with an ARM.
Buying a home is a daunting decision, especially when looking at loan terms. Knowing you will be paying on a loan for 30 years can seem like a lifetime. Refinancing gives homeowners the option to shorten their loan terms, meaning the loan can be paid off sooner. It’s important to remember than refinancing to shorten the loan term doesn’t mean your monthly payment will increase dramatically. Oftentimes, your monthly payment will only increase slightly, and you get more for your money.
Refinancing can be a smart move to reduce your overall debt and allows you to build more equity in your home. Prior to refinancing, ask the right questions. How long will you stay in your home? Will you be saving money? Are you able to lower that interest or shorten the loan term? Talk with you lender about what makes sense for you.
Next week, we’ll share Part II: what are the costs of refinancing and how do you get started? Stay tuned!