Reasons to Refinance Your Mortgage (continued)

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In my last blog post we started discussing the various reasons that a homeowner would look into refinancing a mortgage. We touched on the conversions between adjustable rate and fixed rate mortgages, and the shortening of the mortgage’s term. In this post, we’ll touch on the remaining (common) reasons for refinancing.

Getting A Lower Interest Rate

As with the switch between adjustable rate and fixed rate mortgages, the goal is to save money via interest rates on the loan. When seeking a lower interest rate, it’s always necessary to switch between rate-types. In an environment where interest rates are low, mortgage holders (with fixed rates) may seek out refinancing to obtain another, fixed-rate mortgage with a lower rate. The general rule is to only seek out refinancing if there is an opportunity to reduce the interest rate by 1-2%, anything less will not be worth the upfront costs of the refinance.

 

Debt Consolidation or Accessing Equity

These are some of the most common reasons that mortgage holders will consider refinancing, but they are also the reasons that carry the most risk, from a personal finance perspective.

Some mortgage holders will look to refinancing in order to access their home equity.  The justifications for this move will vary. Some will use the equity to pay off remodeling, which can increase the value of the house, or to purchase more property, which can be a great investment. Others will use the equity to to cover large personal expenses, or pay off other debts.

Other mortgage holders will refinance to try to consolidate their debts; the idea of reducing high interest debt with lower interest debt makes sense on paper. However, many people who are refinancing for this purpose alone will not necessarily be saved from their high-interest (ie: credit card) debt forever. It’s likely that they will accrue more high interest debt with the available credit the refinancing has allowed them.

 

For a great breakdown of how mortgage rates are quoted, view this video by Khan Academy:

Reasons to Refinance A Mortgage

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In the housing market, it’s common to hear the term “refinancing” come up amongst homeowners. In short, refinancing is the act of paying off an existing mortgage loan and getting a new one to replace it. As with any major financial decision, there are upsides and downsides to refinancing a mortgage, and mortgage holders will look into refinancing for a number of different reasons. The end goal however is always the same: to save some money on some aspect of the loan.
Here are a few of the most common reasons for refinancing:

Switching Between Fixed and Adjustable Rates

There are benefits to starting out with fixed rate mortgages and adjustable mortgages, when first taking out a mortgage loan. But those benefits may erode over time, depending on the state of the market.

If the mortgage holder started out with a fixed rate mortgage loan, it may make sense to start looking into refinancing if the interest rates in the market begin to fall. If it looks as though market interest rates will continue to fall over an extended period of time, switching to an adjustable rate mortgage (ARM) would make sense. With an adjustable rate mortgage, there are periodic rate adjustments (that can adjust up or down). The falling rates in the market would result in both a lower interest rate and a smaller monthly payment for holders of an adjustable rate mortgage.

Important Note: Refinancing to an adjustable rate mortgage needs to be heavily considered by the mortgage holder. If they are only considering staying in the home for a few years, then switching to an ARM in a falling interest market makes sense. But, it’s possible for the rates to increase again over time, so that must be taken into consideration.

Conversely, if the mortgage holder started out with an adjustable rate mortgage, it’s possible for the market to enter a state of steadily climbing interest rates. In this situation, periodic adjustments to the mortgage will result in increased interest rates over time. It would make sense for the ARM to be refinanced to a lower, fixed rate mortgage to avoid continued hikes in the interest rate.

Reducing The Term of the Mortgage

Depending on the state of the market, refinancing to shorten the length of the mortgage is also an option. When there are “record low” interest rates, the loan holders may be presented with the opportunity to get out of a 25-30 year fixed rate mortgage. Refinancing to a lower interest rate can result in a shorter overall term, with a monthly payment that’s around the same as what was already being paid.


Check back soon for more information on mortgage refinacing!