When you refinance your mortgage, you pay off your existing loan by replacing it with a new one. Why would someone purposely go through the process of applying for a new mortgage, getting approved, and then refinancing? There are many reasons smart homeowners refinance, and the most common reason is to lower their interest rate.
However, refinancing isn’t always the right choice. The cost of refinancing can be as high as 6% of the loan’s principal, not to mention you’ll also need to consider the application fees and other costs.
There are a lot of things to consider before refinancing your mortgage. The best way to learn whether this is the right step for you as a homeowner is to talk to a financial professional about your current mortgage and debt situation. To begin, we’ll explore when it’s time to refinance your mortgage.
What Does It Mean to Refinance Your Mortgage?
Even if you’re an experienced homeowner, it’s not always clear what it means to refinance your mortgage. When you originally bought your home, you likely needed a mortgage unless you were paying completely in cash. This mortgage had a set of terms and interest rates.
Because mortgage rates are always rising and falling, and your financial situation is always changing, it can be a good idea to refinance. When you refinance, you use a new mortgage to repay your old mortgage, thus replacing it altogether. You’re not limited to your current lender, and you have the option to figure out what works best for you.
Why Do Homeowners Refinance Their Mortgage?
What are the reasons so many homeowners choose to refinance? The most common reason is to achieve a lower interest rate. A lot of lenders say the rule-of-thumb is that you should refinance if you can reduce your interest rate by at least 2%. However, recently many lenders have recommended refinancing even if the difference is 1% in savings.
Why is reducing your interest rate such a good option? It helps you not only save money every month, but it will also increase the rate that you’re building equity in your home. Ultimately, it could make a big difference in your monthly spending as well as your home’s equity.
This is by far the most common reason why homeowners refinance their mortgages, but it’s not the only reason. Some other common reasons include:
- Shortening the loan terms – If interest rates fall, you might refinance to a loan with a shorter term without changing your monthly payment significantly.
- Converting the loan type – If you currently have an adjustable-rate mortgage, you might want to switch to a fixed-rate mortgage to save money and vice versa.
- Access equity – Sometimes homeowners will need to access their equity, usually in order to cover expenses like home repairs or remodelling. A new mortgage can help tap into this equity.
- Consolidate debt – Finally, some homeowners will consolidate their debt into a new loan that includes several types of debts at once, including their mortgage. However, this can be a bad move if you’re not careful.
As you can see, there are a lot of reasons to consider a mortgage refinance. That being said, it’s not always the best idea even when mortgage rates are low.
When Shouldn’t You Go For This Option?
Before you begin the process of gathering your salary information and your financial records to start the mortgage application process, give good thought to why you’re refinancing. While it’s true you can save money if you find the right new mortgage, there can be times where mortgage refinancing is a bad move.
Here are situations where you shouldn’t use mortgage refinancing as a debt solution:
- Debt consolidation – While it’s not uncommon to see people using a mortgage to pay for other types of debt, especially high-interest debt, this could be a slippery slope. If you’re unable to make the payments on your new mortgage, you could lose your home.
- Longer-term loan – If you opt for a longer-term loan with a lower interest rate, you might just end up paying more in the long run since you’re adding years onto your total payment.
- Lower payments (without calculating properly) – While it’s true you can secure lower monthly payments if you lower your interest rate, you need to be very careful to calculate the costs. As we mentioned earlier, refinancing can cost you up to 6% of the home loan, and this is a lot to pay upfront.
The bottom line is that you need to be careful before opting for a mortgage refinance. It’s easy to feel tempted by a lower monthly payment or a shorter payment term, but make sure you’ve done your research and crunched the numbers to know what you’re getting into.
Is a Mortgage Refinance Right For You?
Now that you’ve read through the reasons why you should or shouldn’t refinance your mortgage, which option do you think is right for you? Most likely, you won’t know until you do a bit more research.
Checking the current mortgage rates in your area is a great first step, but don’t stop there. Calculate just how much you’ll need to continue paying monthly in order to pay off your mortgage completely. Is this something you can live with or do you need a change? The answer might not always be so clear.
If you’re ready to take the next step, talk to one of the financial experts at Debt Busters on 1300 368 322. We can help you understand your current mortgage situation, as well as assist you in finding the best refinance option. While refinancing can be a great financial move, it’s may not be right for every homeowner.