We all want to reduce our bills, pay less per month and save more money for us. Refinancing your mortgage could be one way for you to free up some money. There are many reasons why homeowners refinance: to obtain a lower interest rate; to shorten the term of their mortgage; to convert from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, or vice versa; to tap into home equity to finance a large purchase, or to consolidate debt.
Refinancing can cost between 3% and 5% of a loan's principal since it requires an appraisal, title search, and application fees, just like a mortgage would. Because of this it is important for a homeowner to determine whether refinancing is a wise financial decision before starting the process.
Refinancing to Secure a Lower Interest Rate
One of the best reasons to refinance is to lower the interest rate on your existing loan. Historically, the rule of thumb is that refinancing is a good idea if you can reduce your interest rate by at least 2%. However, many lenders say 1% savings is enough of an incentive to refinance.
Reducing your interest rate not only helps you save money, but it also increases the rate at which you build equity in your home, and it can decrease the size of your monthly payment.
Refinancing to Shorten the Loan's Term
When interest rates fall, homeowners often have the opportunity to refinance an existing loan for another loan that without much change in the monthly payment, has a significantly shorter term.
Refinancing to Convert to an Adjustable-Rate or Fixed-Rate Mortgage
While ARMs often start out offering lower rates than fixed-rate mortgages, periodic adjustments can result in rate increases that are higher than the rate available through a fixed-rate mortgage. When this occurs, converting to a fixed-rate mortgage results in a lower interest rate and eliminates concern over future interest rate hikes.
Conversely, converting from a fixed-rate loan to an ARM can be a sound financial strategy if interest rates are falling. If rates continue to fall, the periodic rate adjustments on an ARM result in decreasing rates and smaller monthly mortgage payments eliminating the need to refinance every time rates drop. With mortgage interest rates rising, on the other hand, this would be an unwise strategy.
Converting to an ARM, which often has a lower monthly payment than a fixed-term mortgage, may be a good idea for homeowners who do not plan to stay in their home for more than a few years. If interest rates are falling, these homeowners can reduce their loan's interest rate and monthly payment, but they will not have to worry about future higher interest rates because they will not live in the home long enough.
Refinancing to Tap Equity or Consolidate Debt
Homeowners often access the equity in their homes to cover major expenses, such as the costs of home remodeling or a child's college education. Some homeowners refinance to consolidate their debt. At face value, replacing high-interest debt with a low-interest mortgage is a good idea. Unfortunately, refinancing does not bring automatic financial prudence. Take this step only if you are convinced you can resist the temptation to spend once the refinancing relieves you from debt. It takes years to recoup the 3% to 5% of principal that refinancing costs, so don't do it unless you plan to stay in your current home for more than a few years.
Refinancing can be a great financial move if it reduces your mortgage payment, shortens the term of your loan, or helps you build equity more quickly. When used carefully, it can also be a valuable tool for bringing debt under control. Before you refinance, take a careful look at your financial situation and ask yourself: How long do I plan to continue living in the house? How much money will I save by refinancing? Keep in mind that refinancing costs 3% to 5% of the loan's principal. It takes years to recoup that cost with the savings generated by a lower interest rate or a shorter term. If you are not planning to stay in the home for more than a few years, the cost of refinancing may negate any of the potential savings. It also pays to remember that a savvy homeowner is always looking for ways to reduce debt, build equity, save money, and eliminate their mortgage payment. Taking cash out of your equity when you refinance does not help to achieve any of those goals.
The DuPree Team hopes that you and your family have a successful year and are so happy to have you as part of our real estate family. We hope that you found this information useful and look forward to providing you with curated and informative email blogs on a monthly basis. If there is any topic you think we should cover, please let us know! Please keep us in mind the next time you or anyone you know is looking to buy or sell in South Florida.
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