Refinancing your home loan will ideally replace your current loan with a more favorable one. While the reasons for refinancing may vary, there are a few key objectives that can help you decide whether it’s worth it. It may be in your best interest to refinance if you need to: (1) pay off debt; (2) change your monthly payment; or (3) switch to either a variable or fixed rate loan.
Many Americans struggle with high-interest debt from credit cards. If the interest rate on a new mortgage is lower than the interest rate on such existing debt, you could save a lot of money by refinancing your mortgage with a home equity loan or cash-out refinance. Your mortgage payments could increase and the term of your loan will likely be extended, although the expensive credit card debt would be paid off entirely and rolled into the amount owed on your mortgage.
If you experience a financial setback and are looking to cut costs, refinancing your mortgage at a lower interest rate could lower your monthly mortgage payment amount. For example, if you owe $350,000 on a 30-year loan with a fixed interest rate of 5%, lowering the interest rate by 1% could lower your monthly payment from about $1,879 to $1,671, saving you roughly $2,500 per year. Alternatively, if your financial circumstances improve and you’re able to afford larger monthly payments, it may be to your advantage to refinance your mortgage and shorten the term. Using the previous example, if that same $350,000 loan is shortened to a 15-year term, the monthly payment would increase to $2,768. However, over the life of the loan you would save over $178,000.
Many home loans are adjustable rate mortgages (ARMs), which usually start out as fixed-rate loans and then switch to variable-rate loans after a few years. The major risk with ARMs is that if interest rates increase, then so will your monthly payment, perhaps to an amount that is unaffordable. Refinancing to a fixed rate, while it may increase your monthly payment, will give you certainty on your payment amount without any fear of fluctuating rates. Conversely, if you’re looking to lower your monthly payment, it may be in your best interest to convert from a fixed-rate mortgage to an ARM.