If you’ve taken a home loan, possibly you’re thinking about refinancing your mortgage. With loan interest rates often going down, many homeowners consider refinancing their mortgage at the lowest interest rate they can find. But what is refinancing and when, exactly, is the best time to refinance your mortgage?
So, let’s begin with first understanding what is refinancing. Refinancing your mortgage means paying off an existing loan and replacing it with a new one with better rates/term. Refinancing is basically of two types. When the leftover balance of your existing mortgage is transferred into a new one, it is known as rate-and-term refinance. The second type is cash-out refinance in which the new mortgage consists of the balance of your earlier mortgage, as well as the cash you took out. Whichever option you choose according to your situation, refinancing is a smart way to secure a better deal, save your money, reduce your loan term, and even get extra cash for renovation.
Now, you may ask when you should consider refinancing. People refinance their mortgage for several reasons but here we’ll discuss the most common situations in which refinancing your mortgage is worth considering.
Secure a Lower Interest Rate
Securing a lower rate is probably the main reason people refinance their home loans. A reduction in interest rates means lower monthly payments which make refinancing a viable option. Often people find that interest rates have dropped since they got their original mortgage. So, when you find lower rates, refinancing can reduce the amount of interest you pay and lower your monthly payments. According to experts, you should consider refinancing even if you can reduce your interest rate by 2%. For instance, you took a mortgage of $350,000 at a fixed rate of 6.1% for 30 years. After four years, you find that interest rates have come down to 4%, which means refinancing your loan can help you save a substantial amount over the course of the loan.
Improved Credit Score
If your credit score has improved since the time you took out a loan, refinancing can help you in securing a better rate. In most cases, a 20-point increase in the credit score can help borrowers in reducing their rate which translates into saving thousands of dollars in interest over the entire loan period. For instance, if you have successfully increased your FICO score from 650 to 720 over a period of five years, it may help you in achieving as much as a 1.5% reduction in mortgage rates.
Change Your Mortgage Type
Another reason for refinancing is when you want to convert your mortgage to an Adjustable-Rate or Fixed-Rate Mortgage. Initially, the introductory adjustable-rate mortgage (ARM) offers lower rates as compared to fixed-rate mortgages which make it a lucrative option. However, after a few years, the rates of ARMs might increase and get higher than the rate available through a fixed-rate mortgage. When this happens, it’s better to refinance and choose a fixed-rate plan that fits your budget. Switching to a fixed-rate mortgage can help you in lowering the interest rate and saving in the long-term. Sometimes, the change can also be from a fixed-rate loan to an ARM when interest rates are falling.
Increase or Decrease Your Loan Term
Your financial position doesn’t always remain the same. Depending on whether it has improved or declined, you might need to increase or decrease your loan term. If you’re ready to pay more monthly, you can reduce your loan term. On the other hand, if you need to pay less monthly, it’s better to increase your term. Refinancing to reduce your term is a good option when rates drop significantly because doing this will not have much impact on your monthly payments. For example, if you find that rates have dropped from 6.5% to 4.1%, you may decide to refinance to get a new loan with 15 years term instead of the original 20 years.