Here are four scenarios where a refinance can be smart:
Lower your interest rate
A lower rate can be one of the best reasons to refinance your mortgage. Interest rates may have decreased since you purchased your home, or perhaps your credit score has improved. If you can reduce your interest rate by 1–2%, it can save tens of thousands of dollars in interest over the life of the loan. A lower interest rate can save you money. It allows you to build equity in your home much faster, as more of your monthly payment goes towards paying down the principal.
Shorten your term
Many people buy a home with a 30-year mortgage loan. As your financial situation changes, you may find a 15-year mortgage easy to manage. A shorter term means you’ll pay your home off much faster and save on interest. And, if rates are lower now than when you originally bought your home, you may see very little change in mortgage payment despite a significantly shorter term.
Convert an adjustable-rate to a fixed-rate mortgage
Interest rates on an adjustable-rate mortgage (ARM) typically start lower than fixed-rate mortgage terms, but the rate can change at any time. If mortgage rates decrease, that’s great for you. However, if rates rise, so will your monthly payment. Converting an ARM to a fixed-rate loan offers stability by removing the possibility of future rate hikes.
Tap into equity
This is considered a “cash out” loan, and you are refinancing for more than you currently owe. You can cash out up to 80% of your home’s value in Texas, minus any outstanding mortgage balance. For example, If you owe $150,000 on your mortgage, and your home appraises at $250,000, you could refinance up to $200,000 and receive $50,000 cash out. You can use this money on anything, such as home improvement and repairs, a child’s college education, or debt consolidation.
Other factors present a different picture for refinancing. Here are three scenarios that may cause you to reconsider:
Moving soonKeep in mind, a refinance works just like the mortgage when you first bought your home. There are closing costs associated with most mortgage refinances. If you plan to move anytime soon, you may not reach the break-even point. Calculate the break-even point by dividing the closing costs by the monthly savings from a new mortgage. If closing fees are $8,000 and monthly savings are $250, it would take 32 months to break even.
Longer time to pay offUnless you are refinancing for a shorter term, a refinance makes the most sense earlier into your original mortgage term. If you’re 10 years into a 30-year mortgage, refinancing into a new 30-year mortgage is starting over, essentially making it a 40-year mortgage. Even with a lower interest rate, that means a lot more in interest paid before you own your home.
Debt consolidationAs mentioned above, a cash-out refinance does have benefits, primarily when you use the cash to increase your home’s value. If you are using the money to pay down debt, it is only helpful if you change your spending habits that contributed to your debt in the first place. Suppose you use the loan to consolidate your debt but continue to use your credit cards. In that case, you are only making your debt situation worse.