Refinancing a home loan or mortgage means applying for a new loan to pay off a current loan. There are several reasons why people refinance home loan. It could be to benefit from a decreased interest rate; shorten the mortgage term; switch to a fixed-rate loan arrangement from an ARM (adjustable-rate mortgage), or the other way around; consolidate debt; or use house equity to fund a big purchase.
Securing a Lower Rate of Interest
Lowering interest expense on an existing loan is one of the major reasons why people go the refinancing route. Typically, refinancing is a solid concept if you could decrease your rate of interest by at least two percent. However, several lenders believe even a percent savings should be enough of a fillip to refinance. Reducing interest rate not just helps with saving money, but also increases the speed at which you shape your home equity, and it would reduce your monthly payment size.
Shortening Loan Term
When interest rates nosedive, homeowners usually see the period as the most opportune time to refinance their current loans for other loans. This is for the shortened repayment period, with little to no alterations in monthly payments. For instance, refinancing from nine percent to 5.5 percent on a fixed-rate mortgage for 30 years on a house worth $100,000 could cut the payment period in half with a minor modification in monthly payment, which should be $817 from $805.
Converting to a Fixed-Rate or Adjustable-Rate Mortgage
While ARMs usually begin with offering lower interest rates compared to fixed-rate mortgages, adjustments periodically could lead to increases in rate that are higher compared to a fixed-rate mortgage interest rate. When this happens, switching to fixed-rate mortgage decreases interest rates and negates worries over interest rate hikes in the future.
On the other hand, converting to an ARM from a fixed-rate arrangement could be a wise financial move if the interest rates are going down. If the rates keep falling, the periodic ARM rate adjustments would result in lesser monthly mortgage payments and decreasing rates of interest. This shall eliminate the inclination to refinance each time rates go down. With the increase in mortgage interest rates, however, this would not be a wise move.
Tapping into Equity or Consolidating Debt
Homeowners generally access equity in their houses to cover costs attached to home remodelling, college education of a child, etc. These homeowners usually justify their refinancing move by citing the tax-deductible component attached to mortgage interest. While this argument could be true, increasing the mortgage period would never go in the borrower’s favor.