With mortgage rates at an all-time low, you may be toying with the idea of refinancing your mortgage. This can be for a residential or commercial mortgage.
My mom had an Adjustable Rate Mortgage on her commercial property that was scheduled to increase in April. Since the rates are historically low, she decided to check into refinancing her mortgage.
Of course, she wanted to be sure it was the right financial decision that was going to save her money. You will also want to be sure you refinance your mortgage the right way if you decide to refinance your existing mortgage. The main reason to refinance is to save money long-term, and there are many ways you can do this.
In this article, we will guide you through how to know if refinancing your mortgage is right for you, the reasons to consider refinancing, and how they can save you money.
Here’s what we will cover:
- Lower Interest Rates
- Refinance to a Fixed Rate
- Remove Private Mortgage Insurance
- Refinance into a Shorter Loan Term
- Consolidate Debt
- Cash-Out & Home Renovations
- Refinance or Home Equity Loan
Lower Interest Rates
The main reason people will refinance their mortgage is to get a lower interest rate. However, it’s not really worth it unless you can drop your rate by at least 0.5%.
The reasoning behind this is that you need to consider the cost of refinancing vs. what you will be saving. If you spend thousands of dollars in closing costs then sell your home, you may lose money.
In some cases it may be worth refinancing even if the rate isn’t reduced by 0.50% if an Adjustable Rate is refinanced into a lower fixed rate or refinancing a high loan balance.
It also depends on how long you plan on staying in your home. You may be saving on your monthly mortgage payment, but you need to figure closing costs into the equation.
For instance, if your mortgage payment lowers by $100 per month, but you have $6000 closing costs, it will take you about five years to break even. If you plan on selling your home, it won’t make sense to rack up thousands of dollars in closing costs for short-term monthly savings.
If you plan to stay in your home for more than five years, then refinancing at a lower rate can save you thousands of dollars over the life of the loan.
Let’s say your payment reduces by $75 a month from a cheaper interest rate. $75 a month for 30-years is $27,000! You will save a good chunk of money just by refinancing into a lower rate.
The trick is to take that additional amount you are saving and apply it to your mortgage principal, and you can pay off your home faster and save money too!
Refinance to a Fixed Rate
Is your current loan an adjustable-rate mortgage? If so, refinancing into a fixed-rate loan may be a better option. When you have an adjustable-rate mortgage, your rate is locked in for an introductory period but then can increase to current market rates after that.
That’s great if rates go down, but what if they suddenly jump up? You’ll be stuck paying more than you can probably afford.
It’s easier to budget a fixed-rate mortgage because you know how much your payment will be for the life of the loan. The appeal of an adjustable-rate mortgage is that the rate is low for the introductory period.
However, if the rate increases significantly after that, then you may end up paying more than if you had a fixed-rate mortgage.
Remove Private Mortgage Insurance
If you have an FHA Loan or Conventional Mortgage Loan and did not put a 20% down payment or have 20% equity in your home, then you are paying Private Mortgage Insurance. PMI is insurance that protects the lender in case you are unable to make your payments.
The cost of Private Mortgage Insurances averages .55%-2.25% of the original loan amount. Once you have reached 80% Loan-to-Value of the home with a conventional mortgage loan, it will be removed.
If you have an FHA Loan, then you have to refinance to remove PMI. In this instance, if you plan on staying in your home, refinancing to remove PMI can save quite a bit of money.
For instance, if your original mortgage loan was $150,000 and you’re paying 1% Private Mortgage Insurance, that equals $119 per month for PMI. Suppose you pay this through the entire loan term; this adds to a whopping $42,840! You can save a bundle by refinancing your mortgage to remove PMI.
Refinance into a Shorter Loan Term
If the rate is lower by the .50-1% suggested rate, you can also refinance your mortgage into a shorter-term loan. Rather than a 30-year mortgage loan, you could refinance into a 15-year mortgage loan.
Before you consider a shorter-term loan, you need to be sure you have enough room in your budget for a larger mortgage payment. You don’t want to constrict your budget too tightly or prevent yourself from saving money.
The amount of money you save in interest is enormous. Check out this comparison on a 30-year fixed loan vs. a 15-year fixed loan.
Even with the same rate, the interest payment is cut by 50%! On the 30-year mortgage loan, the total interest paid is $71,315.98.
On the 15-year mortgage loan, the total interest paid is $32,754.36. That is a savings of $38,561.62!
Once you figure out if you can afford a short-term loan with a higher payment, you can look forward to saving thousands of dollars in interest and paying your home off faster!
Another reason to refinance your mortgage is to consolidate high-interest debt into one payment. The downside of this is that you are putting your home at risk, but if you can maintain a debt-free lifestyle, this option can save you a bundle of money.
Depending on the amount of equity you have in your home will determine if you can increase your new mortgage loan to consolidate your debt. If you can do this, it may add to significant savings by reducing high-interest rates to a much lower rate.
Check to see what you will pay in interest with your credit cards and see how much you can save. If you do consolidate your debt, be sure you use your credit cards the right way to prevent further debt.
Cash-Out & Home Renovations
When you refinance for home renovations, you are investing the cash-out back into your home. In some cases, this may increase the value of your home and allow you to make those home improvements you’ve wanted to do but couldn’t quite budget for.
Certain home renovations increase the value more so than others. Renovating and updating your kitchen and bathrooms can increase your home’s value. Adding a deck and investing in landscape and curb appeal makes a great first impression, which is excellent if you decide to resell your home.
The latest desired upgrade is a home office. Now that COVID-19 has prevented some from returning to work and school, a home office is almost essential nowadays.
You can, of course, customize your home the way you want if you plan on staying in it long-term. Maybe you can finally get that in-ground pool you always wanted?
Refinance or Home Equity Loan
If you’re planning on staying in your home and can refinance into a lower interest rate while getting a lump sum of money for needed repairs or debt consolidation, this may be the best way to go.
However, some prefer a Home Equity Loan, which is a separate loan in addition to their original mortgage loan-also known as a second mortgage.
The two types of Home Equity Loans are the Traditional Home Equity Loan and a Home Equity Line of Credit. A Traditional Home Equity Loan is where you borrow a lump sum, and a Home Equity Line of Credit is an open credit line like a credit card where you can borrow as needed.
The pro to a HELOC is the rates tend to be lower than personal loans and credit cards. Also, the closing costs are generally less on a Home Equity Loan than a Refinance Loan.
The cons are you may have to pay a transaction fee when you make withdrawals and an inactivity fee if you don’t use your credit line during the predetermined period.
Just remember to be frugal with your budget to be sure you can afford a HELOC or Home Equity Loan. This is considered a second mortgage, and your home is held as collateral for repayment.
Recap on Refinancing
By refinancing her existing mortgage, my mom was able to drop her rate from 5.44% to 3.99% and save $205 per month. This equals a total of $24,600 she will save by refinancing her mortgage!
The last thing you want to do is refinance into the wrong loan or for the wrong reason. You want to be sure you are setting yourself up for financial success by saving money with your new mortgage loan.
Remember the reasons to refinance can be:
- Lower Your Interest Rate
- Remove Private Mortgage Insurance
- Transfer to a Fixed-Rate Mortgage Loan
- Consolidate Debt
- Cash Out for Home Renovations
By researching and refinancing into the right mortgage loan that benefits you most, you can save your hard-earned money and build-up your savings account or investments instead.
Contributor’s opinions are their own. Always do your own due diligence before investing.
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