What is mortgage refinancing?
Refinancing your mortgage is the process of replacing your current home loan for a new one — this can be done with your existing lender or with a different one, and typically comes with different loan rates and/or terms.
There are a few different reasons you may consider refinancing your home, which we’ll get into a bit more in the section to follow. It’s important to evaluate your reasons for wanting to refinance, and to do your homework in advance to ensure it makes financial sense in both the long and short term.
Why (or when) might I want to refinance?
The most common reason for refinancing is to save money, either by shortening the term of your loan or locking in a lower interest rate – or both. Alternatively, some people want to cash out their home equity to free up money for other uses.
If you have room in your budget, you might consider refinancing to a shorter term loan of 10 to 15 years that carries a lower rate. Moving to a shorter loan will likely mean higher monthly costs, but your home will be paid off more quickly and you will incur less interest overall.
As mortgage rates change, it can be especially tempting to refinance, but it’s important to remember your mortgage costs aren’t limited to your interest rate and simply getting a lower rate won’t necessarily save you money over the life of your loan.
To recoup the costs of refinancing, financial experts typically recommend getting an interest rate that is at least 1% lower and/or having at least 20% equity in your home. If your interest rate would only change slightly, it may not be worth refinancing right now. However, larger loan amounts can show significant difference in payment with as low as a 0.5% change in interest rate.
Mortgage Refinance Pro Tip: Try our Refinance Break-even Mortgage Calculator to calculate the number of months it will take to break-even if you refinance the loan.
In addition to lowering your monthly payment, refinancing to a lower interest rate also helps you build equity in your home more quickly because you’re paying the balance down faster. But remember, refinancing may extend your mortgage and could end up costing you more in interest. If your current loan only has 20 years left, refinancing to a new 30-year loan may save you each month, but adding another 10 years to your mortgage could mean you end up paying more in the end. You also pay more interest at the start of a new loan – especially in the first 10 to 15 years. If possible, keep the length of your loan the same so you can still pay your mortgage off in the same amount of time.
To save even more over the life of your loan, you can choose to put the extra savings from your refinance into an extra principal payment each month. If you can afford it, this can help pay your home off that much faster and you likely won’t feel any changes in your monthly finances.
Mortgage Refinance Pro Tip: Check out our Prepayment Savings Mortgage Calculator to see how additional mortgage payments can help reduce your interest costs by shortening the time it takes to pay off your mortgage.
If you have equity in your home, you can get a cash-out refinance and use the cash to pay for home improvement projects or consolidate debt from credit cards, multiple mortgages or lines of credit.
Keep in mind, the equity you have in your home will drop if you choose a cash-out loan. For example, if your home is worth $250,000 today and your remaining principal is $150,000, then you have $100,000 in equity. If you take out $50,000 in cash with your cash-out refinance, you now have $50,000 in home equity.
If you use the money for home improvements, you may recoup some of the lost equity. On the other hand, if you choose to use the money to consolidate your debt from high-interest rate credit cards, it’s important to make sure you don’t charge too much on your credit cards again and lose your refinance savings.
Mortgage Refinance Pro Tip: Before moving forward with a cash-out refinance, use our debt consolidation calculator to add up the loans you want to combine, and make sure 80% of your home equity (this is the maximum you can borrow) is enough to cover them all in a single loan.
What else do I need to consider?
Before you start the refinance process, check your current loan for a prepayment penalty. If you refinance and pay your current loan off early, a prepayment penalty could add a costly fee that reduces – or even eliminates – your overall savings. Accounting for this fee from the start can help prevent a budget-busting surprise.
Mortgage Refinance Pro Tip: You can use our Early Payoff Mortgage Calculator to determine the additional payment required to pay off your loan early.
Refinancing also means you’ll need to pay closing costs again. These upfront costs include appraisals, credit fees, lender fees, escrow and title fees, and insurance and taxes. Closing costs usually average about 3 to 6% of your loan amount
. If you don’t have the cash on hand, closing costs will be added to your loan amount or may result in “buying up” to a higher interest rate. On average, it takes about two years to pay off closing costs.
As you evaluate your refinancing costs, be sure to add your real estate taxes and home insurance costs too. If you leave these numbers out, you might not be comparing apples to apples or have the full picture of your monthly costs and savings.
Ready to refinance or want to know if it’s right for you?
Greater Nevada Mortgage offers no-cost, no-obligation consultations to find the best fit for you and even offers refinancing options if you are upside down in equity. Connect with a Greater Nevada Mortgage consultant today to learn more and to get pre-approved, or give us a call at (800) 526-6999.