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Refinancing: Five Reasons to Rework your Mortgage

by Amy Lillard

Refinancing your home provides some flexibility for your unique needs. Ideally, refinancing allows you and your family breathing room with monthly bills, or even provides extra income for necessary expenses. But refinancing can be complicated and costly. Before undertaking the process, borrowers should carefully examine their financial situation, and their reasons for refinancing.

Good reasons to refinance include the following:

Lower interest rate.

Say you bought your house with a fixed-rate mortgage. A few years down the road, interest rates have declined since you first obtained your loan. Refinancing is a popular way to take advantage of lower interest and save money. Homeowners who refinance can get a new loan at the lower interest rate, reducing monthly payments, and in some cases, allowing you to pay more principal and reduce your loan.

Things to think about:

• How long will you remain in your home? If you plan on selling your home in the near future, the costs of refinancing may not be worth it. Remember that refinancing incurs some of the same processing and closing fees that your original mortgage did. If you plan on staying in your home for several years, however, the savings you will gain in the form of lower monthly payments can justify the costs of refinancing. Or if you plan to sell your home shortly you should consider obtaining a No Closing Costs mortgage.
• How much lower should interest rates be? When is it worth it to refinance? A general rule of thumb is that a new interest rate should be at least one percentage point lower than your current rate. However that rule of thumb probably no longer applies with the advent of  No Closing Costs refinances.

Build Equity

Refinancing may allow homeowners to build equity in their home more quickly than sticking with the original mortgage. Borrowers who currently have a 30-year mortgage pay principal and interest in their monthly payments. Changing to a 10-, 15-, or 20-year mortgage can reduce the amount of interest paid each month, and increase the principal paid. This means faster growth of equity. However, it also means higher monthly payments. Refinancing to build equity faster is only appropriate for homeowners who can afford an increase in monthly bills.

Change Loan Type

In times when interest rates are higher, many borrowers opt for an adjustable-rate mortgage (ARM). These mortgages are attractive as they have lower interest rates in their early years, and can ease the pain of a higher interest rate environment. ARMs are unpredictable, however, can will go up yearly or even twice a year after the initial teaser rate expires.

What happens in an environment when interest rates go down? People who purchased their home with an ARM may opt to refinance to a fixed-rate mortgage. Payments will go down, and will be stable for the rest of the term. Many ARM lenders plan for this, and build in conversion periods allowing you to change to fixed-rate mortgages for a one-time fee, without massive refinancing costs.

Show Improved Credit

Borrowers with “broken” credit can still obtain mortgages, often with higher interest rates. Over time during homeownership borrowers may repair their credit. Refinancing may be a great way to obtain a more competitive interest rate befitting the homeowner's improved credit ratings. Borrowers can save money with lower interest rates that translate to lower monthly payments, and continue to improve their credit as a result.

Draw on Existing Equity.

Homeowners can tap into the equity they've built with a “cash-out” refinance. Typically, these loans are used to pay for tuition or education, home improvements, debt consolidation and other needs. A lender will usually require a homeowner to have at least five percent equity accumulated to process this refinance.

Carefully analyzing your reasons for refinancing, as well as your unique financial situation, can result in a successful and money-saving process.

Learn more about refinancing with our continuing article series, including the process, costs and types of refinancing, as well as common mistakes and ideal timing.

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Related Article: Refinancing: Know the Process, and the Closing Costs

Related Article: Refinancing: Three Common Types of Refinancings