Why and When you Should Refinance your Mortgage

29 Sep 2020

Replacing your existing mortgage with a new one is termed as “Refinancing”. The process of mortgage refinances works in the same way as you have applied for your first mortgage.

Refinancing a mortgage is more than just  getting a lender with a lower  Rate of interest

Knowing when and why you should proceed with the refinance is based on many factors such as time to recoup your closing costs, present rate of interest and your plan to live there.

People usually keep a close watch at market conditions for some better options and consider refinancing for reasons such as 

  • Lower their payment 
  • Pay off their loan faster
  • Use home equity to better manage debt
  • Get a low rate for the remaining  tenure of  the loan 

How long does it take to refinance the mortgage?

The time taken to refinance the mortgage will depend on your lender and the procedures that will be carried out for credit checks, inspections, and other necessary formalities.

Thanks to technological innovation in recent years which has streamlined the process for the greater good of everyone. 

How to decide when is the right time to refinance your mortgage?

Ideally refinancing is sought to reduce the current interest rate by 1% or more as it allows you to build equity in your home quickly. 

We are sharing below sound reasons for refinancing into a new mortgage. For getting a short tenure of the mortgage

To breathe easy without debt in your name is a different kind of experience altogether. To get rid of debt as soon as possible is the priority of every applicant. To get things rolling into the direction, you first have to check with your lender that there isn’t any prepayment penalty for your mortgage.

If your tenure for a mortgage is 25-30 years, you may shorten it to 15-20 years. This will be useful for you to pay off the debt fast. Taking advantage of the lower interest rates to shorten the tenure is a good option if you’re several years into the current mortgage.

You can make additional payments of principal as an when you get, say a pay hike or an annual bonus. This will cut down on your debts early than it was coined on initially.

To Lower Your Monthly Mortgage Payment

A drop in interest rates is the most common reason why people go ahead with the idea of refinancing. Availing a mortgage at a lower interest rate will put you into the pedestal of paying off a lower monthly payment. 

You’ll have to pay equal fees of 3 to 6% of the loan amount which will involve other costs of your new mortgage. If you wish to recover the cost of refinancing, make sure you are going to stay in your home for a long enough period. 

Let’s understand the concept better with the help of an example. Suppose you have a mortgage loan for 30 years at an interest rate of 6 per cent, of $150,000. You’re shelling out $899 monthly. Then you would pay $323,755, including $173,755 in interest, over the life of the loan.

Five years into the loan, a total payment you would make towards mortgage will be $10,418 towards principal and $43,541 in interest. You wish to refinance your remaining $139,581 of your principal balance with a new fixed-rate mortgage of 4.5% - for the new 30 years.

Consider figuring this out using a mortgage refinance calculator, to see for yourself if this will be a good move for you or not. 

This new lowered interest rate will cut down your monthly mortgage payment by $192 a month  ( from $899 to $707. You’d now pay $254,605, of which $115,024 would be the interest amount, for the entire tenure. Calculate by adding the principal and interest which you paid in the last 5 year on the previous mortgage. Your total cost will be $308,564 ($254,605 + $53,959). 

By refinancing you not only lower your monthly payments but also make a long term saving of $15190 ($173,755 - $158,565).

To switch - mortgage loan type  

You can save a good amount of money by switching your loan to a non-FHA loan if you are currently financing from the FHA. 

A Federal Housing Administration (FHA) loan asks for additional mortgage insurance (MIP) for the life of a loan. If you switch from an FHA loan to a conventional loan, it will save you more by eliminating the insurance part. 

To switch from an adjustable-rate mortgage to a fixed-rate and vice-versa

The popular choice among new-buyers is of adjustable mortgage rates due to its initial offer of lower rates than fixed-rate mortgages.

The downside lies in the fact that the payment could rise - as per current prevailing market rates. But to get a peace of mind and payment that locks in current prevailing interest rates, you can move to a fixed-rate mortgage from ARM.

This can be changed later as and when the situation demands.

Taking Advantage of Improved Credit Score – You can qualify for a lower interest rate with your improved credit score, even if market rates have not fluctuated. You’ll have to check with your existing lender for a better rate showcasing your improved credit score. Or you can also look for a different product. 

Plan to cash out some equity in your home – You could get the refinancing done for your existing mortgage and save some cash for investing in other purposes. A difference in your appraised value and the amount you owe could be refinanced.

You could also get benefitted from the federal income tax deduction by refinancing, which is generally for mortgages and not for credit cards or auto loans. But before making the move, do consult your tax advisor.