Refinancing a mortgage means paying off an existing loan and replacing it with a new one. 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 raise funds to deal with a financial emergency, finance a large purchase, or consolidate debt. Since refinancing can cost between 2% and 5% of a loan’s principal and—as with an original mortgage—requires an appraisal, title search, and application fees, it’s important for a homeowner to determine whether refinancing is a wise financial decision.
1. 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. For example, a 30-year fixed-rate mortgage with an interest rate of 5.5% on a $100,000 home has a principal and interest payment of $568. That same loan at 4.1% reduces your payment to $483.
2. Refinancing to Shorten the Loan’s Term
When interest rates fall, homeowners sometimes have the opportunity to refinance an existing loan for another loan that, without much change in the monthly payment, has a significantly shorter term. For a 30-year fixed-rate mortgage on a $100,000 home, refinancing from 9% to 5.5% can cut the term in half to 15 years with only a slight change in the monthly payment from $804.62 to $817.08. However, if your’e already at 5.5% for 30 years ($568), getting, a 3.5% mortgage for 15 years would raise your payment to $715. So do the math and see what works.
3. 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.2 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—which often has a lower monthly payment than a fixed-term mortgage—can be a sound financial strategy if interest rates are falling, especially for homeowners who do not play to stay in their homes for more than a few years. These homeowners can reduce their loan’s interest rate and monthly payment, but they will not have to worry about how higher rates go 30 years in the future.
4. Refinancing to Tap Equity or Consolidate Debt
While the previously mentioned reasons to refinance are all financially sound, mortgage refinancing can be a slippery slope to never-ending 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. These homeowners may justify the refinancing by the fact that remodeling adds value to the home or that the interest rate on the mortgage loan is less than the rate on money borrowed from another source.
Another justification is that the interest on mortgages is tax deductible.3 While these arguments may be true, increasing the number of years that you owe on your mortgage is rarely a smart financial decision nor is spending a dollar on interest to get a 30-cent tax deduction.
Q-Kapital offers interest rates as low as 3.5%
Rate & Term Refinance
A rate and term refinance allows you to lower your rate, change your loan program (e.g., 5 year ARM to a 30 year fixed) or both. If you would like to take advantage of lower rates and a different loan program this type of refinance loan is a good option.
A cash-out refi allows you to take advantage of current market rates and keep one mortgage loan. If your home is worth more than you owe on your existing mortgage, you may be able to pull out equity and secure a lower interest rate. The tradeoff? A larger loan amount and a prolonged loan amortization. As a general rule of thumb, you may want to consider a cash-out refinance if you need more than $50,000. In order to take advantage of the best rates, you will not want to exceed a 60 percent loan-to-value ratio (what your home is worth versus what you owe) and have at least a 740 credit score.
Cash-out refinancing is also something to consider if you’re paying cash for a home but need the money back right away. The benefit of paying cash for your home eliminates the stress of meeting the contract deadlines as well as the process of obtaining financing for your purchase.
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