“Refinance – yes, no, maybe”? With interest rates at historic lows, I field this question a lot. My response is always the same: “Well, it depends”.
There is no one-size-fits-all answer to the refi question. A multitude of factors are at play here:
- What are you trying to accomplish?
- What are the details of your existing mortgage?
- What other debts do you have?
- How is your monthly cashflow?
- What do you want your finances to be like 30 years from now?
- Will you be okay with having a mortgage payment then?
- How long do you expect to stay in this home?
Every single homeowner’s unique financial planning situation dictates whether refinancing is a beneficial option.
Two big motivations tend to drive homeowners down the refi path: Increasing monthly free cashflow and paying off debt more quickly. Extra cash at the end of each month can help with saving for an emergency, retirement, or another long-term goal. Getting rid of debt leads to a big boost in financial flexibility. Finding the right balance between the two is immensely important.
Here are five common reasons why homeowners refinance:
Reason #1: To lower the monthly mortgage payment.
The mortgage tends to be the biggest monthly bill homeowners face. This expense will be around for a very long time. A 30-year note means 360 months of payments. Payments are a combination of principal (paying back the money you borrowed), interest (what the lender charges for lending you the money), taxes, and insurance. Refinancing to a loan with a lower interest rate can be very beneficial to a homeowner seeking additional cashflow, as the total monthly payment will decrease. Less money going to the monthly mortgage means more available money for other financial needs.
Reason #2: To eliminate PMI.
PMI, or private mortgage insurance, is often required by the lender if the homebuyer is not able to put 20% down at closing. It is a way for lenders to protect themselves from the potential for loan default. PMI is an additional monthly charge to the homeowner built into the mortgage payment. Through a refi, the equity in a home can be utilized to eliminate the PMI requirement, lowering the total monthly mortgage bill.
Reason #3: To eliminate a second mortgage.
Some homebuyers decide to take out a second mortgage during the purchasing process. Second mortgages tend to have higher interest rates than first mortgages, as they are second in line for repayment in the event of default. Refinancing can offer homeowners an opportunity to close out a second mortgage if there is enough equity available. By doing so, homeowners can cut down on the total amount of interest paid on the debt over the lifetime of the loan.
Reason #4: To tap into equity.
One of the big benefits of homeownership is the ability to accumulate equity (the amount of money you would receive in a home sale after loan payoff). Equity can be difficult to access when it is tied up in your house, which is where the refi comes in. Through the refinancing process, homeowners can pull out a chunk of equity. It can be a solid option for working toward other financial priorities, like credit card debt paydown, saving for college, or a big renovation project. This option is usually most prudent when the homeowner plans to live in the house for the foreseeable future. Otherwise, the costs involved with refinancing may not be worth it in the long run.
Reason #5: To cut down on the mortgage term.
The most utilized term for a fixed-rate mortgage is 30 years. Homeowners with accumulated equity and ample cashflow may decide to refinance to cut some years off the term of the loan. By refinancing into a lower interest rate loan, homeowners may be able to transition to a 15 year note with little change to their monthly payment. Going this route is particularly attractive for pre-retirees. Lowering monthly expenses can offer quite a bit of financial freedom during those retirement years.
Trying to figure out if refinancing is the right choice for you and your family? A financial plan can offer plenty of insight into how restructuring your mortgage could impact your unique situation. Want to learn more? Schedule a free initial consultation here.