Home refinance loans could allow you to get a better interest rate on your current loan, or better overall terms, letting you lower your payments moving forward. However, there are also some risks involved; if you aren’t prepared, you could end up increasing your rate.
Should you move forward with refinancing your home, or simply leave things as is?
How Home Refinancing Works
There are many types of refinancing home loans available, but the overall process almost always works the same way. Essentially, you’ll be paying off your existing home loan with the help of a new loan; this new loan will replace your old one. You’ll pay a monthly rate based on your principal and the new loan’s interest rate and terms, and your old loan will completely disappear.
Why Refinance Your Home?
There are a few common reasons why people consider refinancing:
- Getting a better interest rate. The most popular reason for refinancing is an attempt to secure a lower interest rate. If you got a home loan with 5 percent interest, and rates are now 3 percent, you could save a significant amount of money every year by making the switch. There are some important variables to consider before pulling the trigger, including the terms and conditions of both loans, but for the most part, a strictly lower interest rate is a good thing.
- Shortening the term of the loan. Some homeowners try to refinance in an attempt to shorten the term of the loan. For example, standard mortgages are often for 15-year or 30-year terms. If you got an initial mortgage for 30 years, but you’re now making more money and you’re interested in paying off the loan sooner, you might refinance based on a 15-year time horizon.
- Converting to a different type of rate. You may also consider switching if you want a different type of rate assigned to your home loan. Fixed rate mortgages are guaranteed to never change; you’re locked into a specific rate indefinitely. Adjustable rate mortgages (ARMs) are designed to have an interest rate that fluctuates according to market conditions; you may start with a below-average interest rate, but that rate could grow to an above-average rate after a few years. If you want to convert from one to the other, refinancing could help you do it.
- Consolidating debt. Some people want to refinance as a way to consolidate their debt, or gain access to their home equity. For example, if you have a child who’s going to college, refinancing your home loan could give you some immediate access to cash in exchange for higher monthly payments in the future.
Most of these are good motivations, but they still need to be followed intelligently if you’re going to benefit from the deal.
Variables to Consider
These are the most important variables to consider if you’re thinking about refinancing:
- Can your interest rate be improved? If all the other variables are identical, a better interest rate is strictly beneficial for you. The question is, can your interest rate be significantly improved? And if so, what would you have to sacrifice to improve it? Sometimes, you’ll find a lender who can offer you a lower interest rate, but only in exchange for making it an adjustable rate—which may not benefit you in the long run.
- Are you currently in an adjustable or fixed rate mortgage? Though some adjustable rate mortgages work out fine, the standard advice is to avoid ARMs and stick to fixed rate mortgages. If you currently have an ARM, you may want to switch to a fixed rate mortgage; conversely, if you have a fixed rate mortgage, switching to an ARM probably doesn’t make sense.
- Would paying your home off sooner be advantageous? For some people, paying off a home is a major accomplishment and a financial relief; for others, it’s not an immediate priority. If you’re considering refinancing so you can pay off your home sooner, think about the real advantages and disadvantages of the maneuver. Would this substantially improve your financial wellbeing?
- Do you need extra money now? Finally, consider whether you need the extra money, or if there’s a way to consolidate your debt through refinancing. Keep in mind, if you’re desperate for extra cash, home loan refinancing isn’t the only method of cash generation available to you.
The Importance of Shopping for the Best Loan
If you’re in a position to benefit from refinancing a home, you’ll need to shop around to make sure you’re getting the best possible deal. There are many types of home loans available from hundreds, if not thousands of different qualified lenders in your area. Do your research and make sure you understand the nature of your new loan fully before refinancing.