Once you have your home loan, you don’t have to stay with the same deal forever. If you so choose, you have the option to refinance and take out a different home loan. But, is a home refinance worth it?
There are many reasons why you would want to do this, but not all of them will be worth it in the long run. While you may save money, you could also lose money on a home refinance.
When should you refinance your home? Here’s when it’s worth it to do so.
Table of Contents
What Is Home Refinancing?
Firstly, what is home refinancing, and what does it entail? You need to know a bit about it before you decide if a refinance is worth it.
Essentially, you are trading in your current mortgage for a new one. When you do this, you may be able to get a new balance on that loan.
It’s called refinancing, as when you do this, your lender will pay off the old mortgage with the new one.
There are two types of refinancing that you need to be aware of:
Rate and term refinance
When you go with a regular refinancing plan, you’re getting a new mortgage that hopefully will have a lower interest rate, as well as hopefully a shorter payment term.
Many choose to do this if interest rates are low enough that it makes it worth it. If the current interest rates are lower than what you’re currently paying on your home loan, this could be what you’re looking for.
If you choose to do this, you need to be aware that closing costs are still expected. You need to do the math and see if the savings you make will make those costs worth it.
Cash-out refinance
This refinance type allows you to borrow against the equity in your home. Typically, you’ll be able to borrow up to 80% of that equity.
For example, say your home is worth $100,000, and you have already paid off $40,000 of the mortgage. When you get cash-out refinance, you’ll be able to borrow up to $20,000, making your current mortgage $80,000.
The goal here isn’t to save money on the mortgage but instead, borrow the money if needed. For many, it can be a much lower interest loan when they need that cash.
You can use that cash for whatever you like, whether it’s paying off debts or improving your home. Remember, it functions like a regular loan, though, and that money needs to be paid back.
When Is A Home Refinance Worth It?
Now you know what a home refinance is, you need to see if a refinance is worth it in your circumstances. Everyone is different, and you’ll need to consider if it’s right for you.
Here are some times when it may be a good idea to refinance your home loan:
1. To obtain that lower interest rate
This is probably the most common reason why some people choose to refinance their home loans. When they took out their home loan interest rates were much higher, and they want to save some cash by lowering it.
You may have heard the advice that you shouldn’t refinance your mortgage unless you can reduce the interest rate by at least 2%. However, many lenders that a reduction of just 1% can be enough to make it worth it.
Of course, saving money on your mortgage is a good reason to consider refinancing. However, there are other reasons to consider it too.
Refinancing will increase the rate at which you build equity in your home and decrease the monthly payment itself. To find out exactly how much you could save, you can talk to a lender and see what’s available to you.
2. When your credit rating has improved
When you first took out your home loan, your credit rating was a big factor in the interest rate you go. The better your credit rating, the lower interest you’ll generally get.
When you first took out the loan, your credit may have been lower than it is now. If you’ve been working hard to improve that score, then you can use it to get a better deal on your mortgage.
For example, if you have a credit score of 660 – 679, then you may pay up to $76,764 in interest on a fixed-rate mortgage of $150,000. If your credit score is in the 700 to 759 range, then you can save up to $11,202 on that interest.
Because of this, it’s well worth shopping around and seeing if you can get a better deal with a refinanced home loan.
3. To shorten the loan’s term
If interest rates are going down, you may have the option to actually shorten the term of your loan without impacting the monthly payment. In these cases, you can actually pay the loan off sooner.
For example, refinancing a $100,000 fixed-term mortgage from 9% to 5.5% can cut the term from 30 years to just 15 years. The monthly payments would go from $805 to $817.
As you can see, that’s a very minimal difference in monthly payments, but you’ll cut the payment term in half.
Refinancing doesn’t always work out like this, so you’ll need to talk to a lender, do the math, and see if it’ll work for you.
4. To convert to an ARM or fixed-rate mortgage
When you took out your home loan, you either went with an Adjustable Rate Mortgage (ARM) or a fixed-rate mortgage. While it worked at first, it may not be the most favorable mortgage type for you now.
For example, if you started with an ARM, then the periodic adjustments may have made repayments higher than you’d get on a fixed-rate mortgage. If you switch to a fixed-rate mortgage, you’ll be able to get a much better rate.
It works the other way around, too, if you’re on a fixed-rate loan and want to lower your monthly payment. This can work if you switch to an ARM, and it’s often done by people who don’t plan to stay in their homes for more than a few years.
In many cases, this is a good financial strategy, but it all depends on your circumstances. It’s always worth checking with an expert if you think you could benefit here.
5. To tap your equity or consolidate debt
This is something you may want to do, especially if you’re considering a cash-out refinance loan. There are multiple reasons why people do this.
In most cases, tapping equity means paying off other debts. This can be anything from medical debts to credit card bills.
If you’re savvy, this can work as you’ll get a lower interest rate on your debts as you consolidate them this way. You’ll also see the option of deducting that interest from your taxes, which can create more savings.
There are other reasons to do this, such as paying for college for your child or taking your dream vacation if you want to carefully do this plan, as you don’t want to stay in debt for longer than you have to.
6. When your home value has increased
This is another good reason to consider a cash-out refinance loan. You’ll be able to take out a new mortgage that’s larger than the original mortgage and get the difference as a cash loan.
If you’ve made improvements to the home and improved its value, then this could work as a way to secure a loan. You want to be sure that you aren’t paying more in interest than the interest in any other debts you’re using that payout to pay off, though.
When Is A Home Refinance Not Worth It?
These were all good reasons why you should look into refinancing your home, but sometimes you’re not going to benefit if you do so. It’s important to be aware that a refinance is not always worth it in some scenarios.
If you’re considering doing a refi for any of the following reasons, a refinance isn’t going to be worth it.
1. When you’re looking to consolidate debt
On the face of it, using a cash-out refinance to consolidate loans seems like a smart move. You’re moving that debt to a lower interest loan, so you’ll pay off less in the course of the loan.
However, remember that you’re moving all that debt to a secured loan. Your house backs it, so if you can’t keep up those repayments, you may risk losing your home.
If that were to happen, it’s going to have a lot of consequences for you. At the very least, it’s going to leave a bigger mark on your credit history than the nonpayment of credit card debt.
Also, it’s so tempting to run up that debt again as soon as you’ve paid it off. You need to be sure that you won’t do this if you’re going to go with this refinancing option.
2. To get a longer-term loan
Again, on the face of it, a longer-term loan sounds like it makes sense. You’ll have longer to pay the loan, so you won’t have to pay so much every month.
However, if you stretch out your loan from 10 years to 30 years, you’ll pay more interest overall on it. Plus, you’re paying 20 more years of mortgage payments.
You may not make the savings you think you are, so you’ll need to make some calculations and decide if it’s for you.
3. To save for a new home
Are you looking to move home in the next couple of years? If so, refinancing your mortgage won’t work for you.
Some homeowners think that if they refinance and get a lower interest rate, they can use those savings for a new home. The fact is, though, it takes three years to start seeing savings as you’ll need to recoup those closing costs.
If you’re hoping to move in more than three years, then this strategy may work for you. If you hope to move sooner than later, you’re actually not going to see savings this way.
4. To use the cash for investing
Some feel that they could make more on the equity in their home if they get a cash-out refinance and invest the money they get from it. On paper, that could happen, but in reality, it just doesn’t work like that.
The stock market is often rocky, and you’re not guaranteed to get out what you put in. You’re often better off paying a mortgage a 4% interest than putting the cash in a CD at 2% interest.
You really need to be an experienced investor to use the equity in your home to make money. You need to understand all the risks if you’re even going to attempt it.
5. To take advantage of a ‘no cost’ refinance
Sometimes, you’ll see a refinancing option advertised as being ‘no cost.’ You need to be wary, as there really is no such thing as a no-cost refinance.
There are always closing fees and costs when refinancing, and they need to be paid in one way or another. You may not see it on the breakdown of the mortgage, but they will be included.
Because of this, the costs of your mortgage may be more than you’d think. For example, the lender may increase interest rates or include closing points.
It’s best never to take a ‘no cost’ refinance at face value. Check all the costs, as it can end up costing you more in the long run.
6. To reduce monthly payments
Yes, reducing your monthly payments is a good reason to look into home loan refinancing. However, it may not be as cost-effective as you’d think.
In some cases, you’ll actually be making more monthly payments overall. While the amount you pay each month has decreased, you may find yourself paying more over time, so be aware of this.
There are lots of reasons why you may want to refinance your home loan. Talk to a lender today to see if a refinance is worth it and to see what’s available to you.
