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WHEN IS REFINANCING A MORTGAGE WORTH IT? CONSIDER THESE 6 SCENARIOS

October 20, 2020
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Picture this: The camera zooms in on a couple sitting at their dining room table
surrounded by paperwork, a computer, and calculator. It’s a common scene of two
homeowners who are thinking about refinancing, but they’re confused by the
entire thing – term lengths, interest rates, loan principles, etc.

Before yelling “Action!” on your refinance, you’ll want to make sure it makes
sense financially and/or with your needs. Not every scenario does. Sometimes all
you need is one take — your first mortgage — to get it right. Other times, you
should have another go at it. So, how do you determine if refinancing is worth
it?

Our guide will help you steal the scene when it comes to making a home
refinancing decision, but first, here are some factors to think about
beforehand.


SETTING THE SCENE: WHAT TO CONSIDER BEFORE A HOME REFINANCE

Breaking down the basics of a mortgage refinance is a good place to start.
Whether you should refinance depends on several factors, including:

Time

 * The length of time you’ve owned your home
 * How long you plan to stay in your current home
 * Your breakeven point — the amount of time that’s needed for your interest
   savings to exceed your refi closing costs

Money

 * The amount you initially borrowed
 * How much of your loan is outstanding
 * Expense of closing costs — appraisal, title search, application fees, and
   more, which can cost between 2% and 5% of your loan’s principal

Terms

 * Your current interest rate
 * Your current loan term
 * Your new loan conditions

Background/Goals

 * Your credit history and score
 * Whether you’re looking to withdraw cash (aka equity) from your home
 * Your other refinance goals

Related: 4 Reasons to Consider Refinancing Your Home

And whether you’re considering a rate-and-term, a cash-out, or a cash-in refi
(the three most common types of refinancing loans), a refinance calculator can
help you make sense of it all. You can utilize it in the following scenarios to
see whether refinancing is worth it from a financial perspective.


WHEN TO REFINANCE YOUR MORTGAGE


SCENARIO 1: OBTAINING A LOWER INTEREST RATE

Getting a mortgage with a better interest rate is one of the main reasons to
consider refinancing. Reducing your interest rate lowers how much you pay in
interest each month, as well as the total amount you pay for your home.

For example, let’s say you’ve lived in your house that’s worth $200,000 for five
years and have built 25% equity in it. You have a 30-year fixed-rate mortgage
with a 5.0% interest rate. If you refinance to a new loan with a 3.5% interest
rate, you could save $176 a month, or over the life of the loan, more than
$63,360. Use our mortgage calculator to see how your specific scenario plays
out.

If you refinance to a loan with a lower interest rate and a shorter term (from a
30-year fixed-rate loan to a 15-year fixed-rate), it may not reduce the amount
of your monthly payment (in some instances, it could even increase), but you’ll
still pay less overall in interest over the life of your mortgage.

Our take: Interest rates are at near historic lows, which might mean the time is
right for a refi. A good rule of thumb to follow is to refinance if you can
secure a rate that’s at least 1% lower than your previous one. Doing so could
mean serious savings.


SCENARIO 2: REDUCING THE TOTAL COST OF YOUR MONTHLY MORTGAGE PAYMENT

Refinancing to lower your interest rate can shrink your mortgage bill. But it’s
not always possible to improve your rate. If a better interest rate isn’t an
option, you can reduce your monthly costs by refinancing to a mortgage with a
longer term than the repayment period that’s left on your current loan.

Our take: There’s a trade-off when refinancing to a longer loan term. Since
you’re increasing your repayment period, you’ll pay more in interest over the
life of your loan. But your monthly costs become more manageable, so it could be
worth it if your budget is tight.

Related: Avoid These 8 Home Refinancing Mistakes


SCENARIO 3: CONVERTING FROM AN ADJUSTABLE-RATE MORTGAGE TO A FIXED-RATE ONE

Adjustable-rate mortgages (ARMs) can be an alluring option for home buyers
because you can secure a lower introductory rate during the early years of
owning your house. In exchange, your loan’s rate has the potential to increase
after that initial period. If interest rates have gone up since purchasing your
home, you’re likely looking at a higher rate when your ARM adjusts — putting an
unexpected strain on your budget.

Our take: If interest rates start to inch upward, you may want to consider
refinancing your ARM to a fixed-rate mortgage, which will offer consistent
monthly payments. But if rates continue to fall, the periodic rate adjustments
on an ARM mean decreasing rates — and smaller monthly mortgage payments —
eliminating the need to refinance to take advantage of a rate drop.

Related: 8 Steps to Refinance Your Mortgage


SCENARIO 4: PAYING OFF YOUR HOME FASTER

When interest rates fall, you could have the opportunity to refinance your
existing loan for another one that allows you to pay off your home faster
without much change to your monthly payment. Reducing your loan term can also
lower the total amount of interest you pay over time, but your ability to do so
greatly depends on your financial capability and flexibility.

Our take: Math always counts when it comes to refinancing, but it’s particularly
important in this scenario. For instance, with a $200,000 home loan at a 5.5%
fixed rate for 30 years, your monthly mortgage payment costs you $1,136. A
15-year, fixed-rate mortgage with an interest rate of 3.5% would raise your
payment to $1,430. That’s a difference of $294 a month, which might be out of
reach. In your particular situation, you might experience less of an increase to
your monthly costs.


SCENARIO 5: USING YOUR HOME’S EQUITY TO FINANCE SOMETHING ELSE

If you’ve owned your home for a considerable amount of time or your home’s value
has increased since you first purchased it, you could tap into the equity you’ve
built (the money you’ve already paid towards your house) by refinancing  — aka,
a cash-out refinance. And those funds could be used for things like:

 * Completing significant home repairs, like new windows or exterior siding
 * Making long-sought home renovations, like that sparkling new bathroom
 * Paying for yourself or someone else to go to school

Our take: Expenses such as these can sometimes be hard to save up for, and a
cash-out refinance can provide the money you need. Some improvements will boost
the value of your home, while others won’t. But you may want to do renovations
for your own enjoyment — even if they aren’t dire or don’t increase your
property value. If you tap your equity to pay for something non house-related,
what matters is that you should feel like it’s worth it and you’re willing to
add to the cost of your home in order to get it.


SCENARIO 6: CONSOLIDATING DEBT

A debt-consolidation refinance lets you refinance to a fixed-rate while pulling
out equity to pay off outstanding non-mortgage debt. When used carefully, it can
be a valuable tool to pay back a debt that sometimes seems impossible. For
example, a typical credit card has an interest rate of anywhere from 13% to 25%
while mortgage interest rates are typically less than 10%. So, converting this
high-interest credit card debt into a lower-interest mortgage could offer
significant savings.

Our take: Refinancing to consolidate your debt under a more manageable umbrella
of a lower interest mortgage may finally give you the path toward living
debt-free. But you should try to resist the temptation to spend again once the
refinancing gives you that freedom.

In the end, a home refi is a decision that’s unique to your own circumstances.
You may yell “Cut!” on your first mortgage because it’ll save you a lot on
interest. Or you may be beyond your breakeven point, but need to consolidate
debt or pull out cash to pay for other expenses. Our mortgage calculator can
help you make sense whether take two on your home — a mortgage refinance — is an
award-winning move for your situation.

Take a look at our competitive rates across various types of mortgages.

Start today.


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