Refinancing is the process of replacing a current mortgage with a new debt obligation.
Typically, people refinance when they can find a better interest rate and better terms, but there are other reasons to refinance as well.
Generally, refinancing can be a time-consuming process. It can also cost anywhere from 3 to 6% of the loan’s principal, so it’s important to understand if refinancing is the best decision for your real estate investment.
Fortunately, there are a few key indicators where refinancing objectively becomes the better financial decision. Let’s look through them.
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- The Pros & Cons of Refinancing Your Home
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Refinance When You Can Secure A Lower Interest Rate
If you’re able to secure interest rates lower than your original mortgage, refinancing could help you save money on your monthly payments and over the life of the loan.
Saving 3% on a $100,000 loan, for example, translates to $3,000 over the first five years. Even just a 1% difference in interest rates can save you thousands of dollars, so it’s worth considering if rates have dropped since you originally got your mortgage.
In addition to a lower total payout, your monthly repayments will also decrease. This can help bring up your cash flow and equity month-on-month.
Refinance When You Need to Convert to Fixed Rate (Or ARM) Mortgage Plans
The terms of your mortgage can also dictate when refinancing becomes a good idea.
If you have an adjustable-rate mortgage (ARM), for example, your interest rate will rise and fall with the market.
While this can result in lower payments during periods of low-interest rates, it also means your payments could jump significantly if rates go up.
Converting to a fixed-rate mortgage can protect you from rate hikes and give you more stability in your monthly payments.
Refinance When You Want to Shorten Your Loan’s Term
Another reason to refinance is if you want to shorten the length of your loan. This process allows you to pay at a faster rate than your original loan. This is ideal if you’re able to secure a loan that doesn’t differ drastically in fees but enjoys a shorter term.
You’ll have to consider whether or not you can afford the higher monthly payments that come with a shorter loan, but it may be worth it when interest rates fall.
Imagine that a fixed-rate 30-year mortgage for $100,000 at 4% interest will have a fixed rate per month. If you refinance to a 15-year mortgage at 3.5%, your monthly payments will increase, but you’ll save thousands of dollars in interest and pay off your loan sooner.
However, in some cases, refinancing when you’re already deep into paying off your mortgage can have the opposite effect and require you to pay more money than your original loan, even with lower interest rates.
So it’s best to calculate your refinancing loans with a tool like this Homestar Finance mortgage switching calculator and see what works best for your specific scenario.
Refinance to Increase Your Property’s Worth
The next reason to refinance is when you want to increase the worth of your property.
Some homeowners refinance to increase the value of their property. This can be done through remodelling and renovation, but there are ways to do it for less.
While this reason doesn’t save you money in the long run, it can be a good investment if you plan on selling your property in the future.
It’s also worth considering that, as your property value goes up, so does your equity. You can use this increased equity as collateral for a home equity loan or line of credit, which can be used for home repairs, debt consolidation, or other expenses.
However, acquiring more loans can also be a risky endeavour. Replacing high-interest debt for low-interest mortgages may seem like a desirable option, but it can put your home and finances at risk if you’re unable to pay the recurring fees of each part of the deal.
Refinance Due to A Financial Emergency
When all your other means of acquiring funds are exhausted, refinancing can be a viable option to obtain the cash you need.
This is usually a last resort, as it comes with additional costs, such as closing costs and fees. It can also be highly risky.
However, if you’re in a tough financial situation and require immediate cash, it may be worth it to get a lower interest rate and consolidate your debt.
Conclusion
Refinancing your mortgage is a risky endeavour. However, if done properly, refinancing can be a great way to save thousands of dollars on loan repayments.
Regardless, you’ll need to consider your current financial situation, as well as your long-term goals, to decide if refinancing is right for you.
If you’re considering refinancing, make sure to do your research and compare different lenders to get the best rate.
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