What You Need To Know About Refinancing Your Mortgage
Mortgage refinancing is an important tool that all homeowners should maintain an understanding of. Refinancing is essentially the restructuring of your mortgage agreement with a lender through the use of a new loan to alter the terms. In a more direct sense, homeowners functionally engage a bank or other financial institution to provide them with the funding to completely pay off the original loan, tapping into the capital at new loan terms or a higher draw amount that provides liquid cash in exchange for equity.
Refinancing can be used to lower an interest rate or to gain access to relatively cheap cash that can pay for renovations to the property. These are typical use cases for this feature of the mortgage landscape. However, it's also important to note that refinancing can be a handy tool in certain circumstances and a very poor decision in others. Investopedia notes that a refinanced mortgage can deepen the effects of debt problems if done at an inopportune time.
Even though the decision to refinance your mortgage (or not) can be complicated and influenced by any number of external factors, there are a few core truths about the use of this financial mobility tool. Learning how refinancing works and understanding the basic utility and use cases for this opportunity can help you make better decisions about your home and personal finances for life.
Refinancing a mortgage is the process of originating a new loan
The basic premise of a refinanced mortgage is to use a new lending agreement to supersede the old one. This gives homeowners access to newly formulated terms that can be beneficial in a number of important ways. Yet, this also provides a window into understanding when it might not be a good time to refinance your mortgage. Namely, if you are happy with the way your financial circumstances stack up in the present moment, shaking up how you pay your mortgage loan may be an unnecessary hassle and change that won't contribute to many benefits.
Conversely, using mortgage loan refinancing is done to accomplish some kind of fiscal goal. Understanding your own goals and needs can help you make sense of the process and the potential value of the decision (via NerdWallet). Taking out a new loan to change the terms of your existing financial arrangement can be used to alter the amount of equity you own in the home — extracting capital for the purpose of your own personal need or design.
You can also use it to transform the repayment period without changing the dollar amount in the loan principal. Regardless, LendingTree reports that a mortgage refinance will typically cost between 2% and 6% of the loan's principal value, meaning this decision can potentially be fairly costly for a homeowner. However, the benefits should outweigh these costs at a bare minimum.
A mortgage refinance can lower your monthly payments
Refinancing your mortgage can provide lower ongoing payments each month. This is a great reason to consider mortgage augmentation through refinancing (via Investopedia). Lowering your monthly payments is a great result for any type of bill you might owe, and a change here can allow for an expansion elsewhere.
Homeowners are often faced with difficult budgeting decisions when it comes to the bills they owe and the expenses that make for a more exciting and fun-filled lifestyle. Unfortunately, there aren't many opportunities to bring more capital to the budgetary equation that don't involve dramatic changes. Even then, many people can't successfully land a new job that pays much better or have the time required to add a financially viable side hustle without breaking their backs with unsustainable working hours in the process (via The Ascent).
Instead, homeowners looking to stretch their budget to accommodate something new must find ways to reduce costs. A dramatically lowered mortgage payment can accomplish this with ease. By changing the terms of your mortgage loan without augmenting the amount owed, you can manipulate the monthly contribution in a way that eases the pressure on your overall expense calculations in a substantial way.
You can extract equity from the property through refinancing
Alternatively, many homeowners consider refinancing their home mortgage in order to achieve the opposite. Instead of focusing on a reduced monthly payment, increasing the amount you owe on the mortgage can be financially viable as you can use this additional cash to facilitate a home improvement project.
In addition, many renovations provide a huge return on investment. This means you may be able to borrow capital from the value of the home itself, finance renovations that break even, or even add overall value to the home's appraisal and only effectively pay the difference in interest and origination costs over the remaining term of the loan. This approach makes financing home improvements a virtually unfelt expense in many instances.
Loans.com.au reports that refinancing to create the capital necessary to fund a renovation can help you quickly and easily finance the project. Likewise, Bankrate reports a national average rate for refinancing at 5.89% (as of June 24, 2022). This rate is substantially lower than credit card interest figures and notably outperforms the marketplace in all other forms of financing as well. In addition, your home's equity makes for great leverage when seeking access to low-cost lending products with big impact value.
You'll have to pay loan origination costs all over again
While the benefits of a refinancing approach can be immense, there are some things to keep in mind when using this form of lending. First, when you refinance your mortgage, you're taking out a new loan to replace the existing one. This means you'll have to pay origination fees, apprise the property, and more. Starting all over again can be costly, and Investopedia notes that this typically ranges between 3% and 6% of the principal balance.
Over the long term, this isn't much of a problem, as the savings you stand to enjoy with lower monthly payments, a more favorable rate, or an immensely transformed property value tip the fiscal balance in your favor. However, it's usually only a good idea to refinance your mortgage if you plan to remain in the home for many more years.
This opportunity is an investment in your future financial situation: With inflation and earning power adjustments over the long term taken into consideration, a reduction in the total owed or ongoing payments will provide a small boost in the immediate present and a much larger impact over time. The same goes for the cost of this transformation. As you continue to reside in the home, the gain will pay for itself many times over, but only if you allow the cost and benefit equation to mature.
Refinancing allows the use of different loan durations or interest rate arrangements
Refinancing can be done for a number of reasons, but the most important thing to remember is that it can take on a number of different formats that each benefit homeowners in a different way. The Mortgage Reports estimates that interest rate reduction is one of the most important features of the refinancing landscape. A change of even 1% on your mortgage loan rate can mean the difference in tens of thousands of dollars over the long term and signal the worth of this action.
Investopedia suggests using a mortgage calculator to evaluate your personal circumstances in order to take in a more nuanced view of your individual financial landscape. According to them, a signpost of around 2% is a great benchmark; however, a larger or lesser rate reduction may work perfectly for what you are hoping to accomplish.
Refinancing to take advantage of a lower interest rate is only the beginning of the available opportunities. Changing the loan duration, for instance, can help you pay off the mortgage faster and, after a few years of equity-building, can make for a virtually negligible change in the amount you pay each month (while dramatically reducing the interest owed on loan through a faster payoff timeline). Considering all your options for refinancing and how they will benefit your unique situation is crucial to making the best decision for your family and future.