Winston Churchill once said, “there is nothing wrong with change, if it is in the right direction.” The same reasoning applies to home refinancing. You can improve your financial situation with a mortgage refinance — as long as you pursue this change for the right reasons.
Lowering the rate
The mortgage interest rate that you’ve been paying may be higher than what’s available on the current market, so it may make sense to refinance to a new low rate. Use a mortgage calculator to determine the total interest costs left on your existing mortgage, and what you’ll pay — including closing costs — on the new mortgage. If you reset your final payoff date for another 30 years, the new mortgage could end up being more expensive despite the lower rate, because the first few years are interest-intensive.
If you’ve recently improved your credit score and financial situation, a refinance may be the right move because you’ll be able to snare a better rate. It will reduce your monthly payment, and could lower your total interest costs.
Building equity more quickly
In certain scenarios, a higher monthly mortgage payment can have financial benefits. Assuming that you can afford it, the higher payment allows you to build equity and reduce debt faster. The combination of higher equity and lower debt adds stability to your overall financial picture.
You can achieve this goal by restructuring your home loan into a shorter maturity. The traditional choice is a 15-year mortgage, because they have slightly lower interest rates than 30-year loans. Your monthly payment would still be higher because you’d be paying the debt off over a shorter period of time, but your total interest costs would be substantially lower.
A cash-out refinance is a viable option when you need money to purchase a long-term asset — items that you’ll use and benefit from for many years. Examples are home renovations, a college degree, and real estate property. Cash-out refinances don’t make sense for vacations, clothes, and cars.
Lowering your risk
Refinancing to a fixed-rate mortgage can reduce risk if you currently have a balloon payment loan or adjustable-rate mortgage (ARM). Today’s low inflation level may make your ARM seem pretty attractive, but there’s no telling what could happen in a few years. Balloon payments are scary because you can’t predict what the lending environment will be like when your big payment comes due.
If you have two mortgages, consider consolidating them into one with a mortgage refinance. Your goal is to have an overall lower interest rate and payment, assuming that you have at least 20 percent equity in your home. Consolidating other types of debt into a refinance is a little riskier. Avoid rolling credit card debt into your mortgage — this strategy often backfires, particularly if you continue using your credit accounts.
Refinancing is a good way to build equity faster, finance a long-term asset, and to lower your rate, your overall interest costs, or your risk. These could all be considered “right” reasons.
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