Refinancing involves paying off your current mortgage and replacing it with a new mortgage. It often involves many of the same steps and expenses that were required when the original mortgage was obtained.
The most common reason to refinance is to lower monthly mortgage payments, but there are other reasons to consider refinancing.
Lower the Monthly Payment: If interest rates have dropped, refinancing may lower your mortgage payment. This is the primary reason people refinance.
Reduce the Term (Length) of the Mortgage: A drop in interest rates may allow you to shorten the amount of time you pay the mortgage but leave the mortgage payment about the same.
Reduce the Risk on an Adjustable Rate Mortgage (ARM): An ARM mortgage may have enabled you to afford your home but if the interest rate has increased significantly, evaluate a fixed-rate alternative. The risk of further interest rate increases is then eliminated.
Use the Home's Equity: As an alternative to a home equity loan, you may elect to refinance your home for an amount greater than the remaining balance of your mortgage. This is known as a "cash out" loan.
Consolidate Debts: An owner with outstanding loans or credit card balances that have high interest rates can consolidate these loans into one new mortgage.
Whether or not to refinance depends on your own personal financial situation. There are many mortgage options available — examine each option thoroughly. Depending on your situation, the best option may be to do nothing at all.
Points to consider:
Do you have the funds that refinancing may require to cover up-front costs and fees?
Refinancing your mortgage may require you to pay substantial up-front costs and fees. If you do not have enough money to pay the up-front costs completely it may be possible to finance some of the up-front costs by including them in the new mortgage.
How long will it take to recover the costs of refinancing?
The rule of thumb is that refinancing costs are recovered within 2-3 years. If you plan to sell the house or pay it off shortly, you may not want to refinance because you will not recover the costs. Obviously, this depends on the up-front costs and the savings with the new mortgage.
Has your income increased substantially?
If your income has increased substantially you may be able to afford higher monthly payments. This may allow you to shorten the term of your mortgage. If the prevailing interest rate is lower for the shorter term mortgage, refinancing is a good option. Alternatively, you may prefer to make larger principal payments against your current mortgage.
Is your current loan an Adjustable Rate Mortgage (ARM)?
If the current rates for fixed-rate mortgages are the same or slightly higher than the rate for your ARM, refinancing may make sense.
Much thought needs to go into the refinancing decision — re-evaluate this decision regularly to account for changes both in your financial situation and the economy. Perhaps your decision is not to refinance now; if it makes since to do so in a few years it may save you thousands of dollars.