What is refinancing and how can it impact your mortgage?
Did you know you can pay off your mortgage with a new loan? That’s called refinancing, and it’s a process some homeowners use as part of their overall financial strategy.
But why would you want to refinance your home? And are there any downsides? As with many things related to owning your home, there are pros and cons to weigh before you make the decision to refinance.
If you want to learn about what refinancing can do for you, keep reading!
What is refinancing?
As we said above, refinancing is the process of replacing your existing mortgage with a new loan. People refinance for a number of reasons, but some of the common ones are:
To get a better interest rate.
To shorten the length of your mortgage.
To get cash for the equity you’ve built in your home.
To change loan types, like going from an adjustable-rate to a fixed-rate mortgage.
Why might you want to refinance your home?
Many people refinance to get better loan terms, mostly by reducing their interest rate. A small change makes a big difference! Look at how much money you can save over the course of a mortgage if you reduce your interest rate:
Scenario one
$150,000 mortgage loan, 6% interest rate, 30-year term
Monthly payment is $939
Amount paid over the lifetime of the loan is $338,040
Scenario two
$150,000 mortgage loan, 5% interest rate, 30-year term
Monthly payment is $864
Amount paid over the lifetime of the loan is $311,040
You can see how a marginally lower interest rate can have an enormous impact on how much you spend on your mortgage. In this scenario, you spend $27,000 less over 30 years when your interest rate is one percentage point lower.
People also refinance to realize the equity in their mortgages. Equity is the value you gain when your home appreciates or increases in value. Sometimes, you use the cash for another purpose. Other times, you apply the proceeds toward your new mortgage to further decrease your monthly expenses.
When is refinancing not a good option?
While refinancing can get you a lower interest rate if the market conditions are right, you need to consider a few things first.
You have to pay closing costs on your new loan, which can range from 3% to 6% of the loan amount.
Your new loan will have its own term length. Refinancing may mean you carry a mortgage for longer than staying with your current loan.
You pay more interest to the bank than toward your principal balance at the beginning of your mortgage. If you need to get cash for your equity, and your home value hasn’t appreciated much, you won’t have much equity to gain.
If the amount you’ve paid to your current provider, plus the closing costs and the total output for having a new, longer mortgage, is more expensive long term, then it may not be a wise financial decision.
Overall, refinancing is neither good nor bad. It’s a tool that could help you make your mortgage work better for you! The most important thing is to talk with a trusted financial professional about the costs and benefits in your specific situation to make an informed decision.