With interest rates dropping yet again, it’s no surprise that many people are considering the wisdom of refinancing their mortgage. Securing a lower interest rate is usually the best reason to refinance, but there are a few other scenarios that make it a sensible choice. The reverse is true too – there are certain motivating factors that will likely make a refinance a bad decision. Here are the good and bad reasons to refinance your mortgage.
What is a Refinance?
When homeowners refinance their loan, they’re paying off the existing debt and replacing it with new debt. Typically, a refinance costs between 2 and 6% of the loan principal and usually requires an appraisal, title search, and application fees. Because of these costs, homeowners should think carefully about their motivations for refinancing.
Financially Sound Motivations
There are a few sensible reasons a homeowner may investigate a refinance. In addition to a lower interest rate, they may be motivated to shorten the term of their mortgage or convert from one kind of loan to another.
Securing a lower interest rate – While the historic rule of thumb is that a refinance is a great decision if it means you’ll reduce your interest rate by 2%, even a 1% savings can mean a a lot. That’s because a lower interest rate means you’re saving money over the life of the loan, boosting the speed at which you build equity, and possibly spend less on your monthly payment.
Shortening the loan term – Falling interest rates can mean opportunity for homeowners to refinance for a shorter loan term without a dramatic change in their monthly payment.
Converting the loan – Homeowners with an adjustable-rate mortgage may be interested in converting to a fixed rate, or vice versa. There are several scenarios in which converting the loan makes a lot of financial sense, and the Cushing Team at Guild Mortgage here in Reno is happy to offer personalized guidance here.
Potential for Trouble
Not all reasons for seeking a mortgage refinance make financial sense. In some cases, a refinance can set you up for debt problems that last well into the future.
Tapping equity – From home renovations to college educations, there are lots of reasons homeowners may consider refinancing as a means of accessing their home’s equity. Whether this is justified by the argument that you’re adding value with a renovation, enjoying a lower interest rate on a mortgage loan in comparison to other loan options, or getting tax-deductible interest, the fact remains – you’re adding years to what you owe.
Consolidating debt – It may seem like a tidy way to pay down debt elsewhere, but refinancing to consolidate debt won’t necessarily sort out your money troubles. If you created a lot of high-interest debt in the past with purchases, consider carefully whether you’re likely to do it again.
There are a lot of reasons to refinance a mortgage loan, and some of them are financially savvy. Remember, that 2 to 6% paid on principal will take years to recoup with the savings on the lowered interest rate, so a refinance likely won’t make financial sense if you’re planning on moving in a few years. If the goal is reducing debt, building equity, and working toward owning your home free and clear, talk to the Cushing Team in Reno today to learn more about how a refinance can help you make all of that a reality.