Refinancing is a popular way to pull money out of your home. However, it’s not an appropriate decision in all circumstances. In this short article, we’re going to take a look at the scenarios of when you should and when you shouldn’t refinance your existing home.
What Is Refinancing?
Before we get into the dos and don’ts of refinancing your home, we’re going to discuss the actual refinance process. Refinancing a mortgage on your home is basically paying off the existing loan and replacing it with a new one. When this process happens, it will cost between two and five percent of the principal loan amount. This is because you must undergo an appraisal, title search, and application fees.
Refinancing can be sought after for several reasons. It could be to pull money out of a home because the house values have gone up or the loan has been paid down by a significant amount. It could be to take advantage of a lower interest rate. It could be to change from an adjustable-rate mortgage to a fixed-rate mortgage. Let’s break down some of the most popular reasons that are acceptable as reasons to refinance your home.
When Refinancing Makes Sense
As you learned above, refinancing your home has a time and a place. Generally, refinancing is a great idea to take advantage of lower interest rates, switch the type of interest that you’re being charged, or to tap into existing equity in your home. We’re going to assess each one of these individual scenarios below.
Taking Advantage Of Lower Interest Rates
Unfortunately, interest rates fluctuate over time depending on the housing market. You may have purchased your existing home when interest rates were high. If interest rates have dropped, especially due to the economic pandemic, then you may want to take advantage of a lower interest rate. When proceeding with this type of loan, it’s important to keep the same term length. You’ll benefit from having lower monthly payments due to owing less interest for the life of the loan.
Switching From ARM To FRM
Adjustable-rate mortgages have been shown off as a very cheap way to pay for a home. The problem is that the interest rate can change without warning. Most individuals find themselves having an extremely high interest rate on their home loan after the first two years. This is because most ARMs come with a standardized rate for the first two years. After that, the interest rate can fluctuate tremendously. This will alter your house payment. Many will decide to switch to a fixed-rate mortgage because it will provide a consistent monthly payment amount. FRMs don’t change with the market.
This reason can sway in the good or bad category depending on how the extra equity is used. If the equity is withdrawn through your home mortgage to pay off high-interest credit cards, this could be positive. This is because you can pay off the credit card balances at a much lower interest rate. In general, tapping the equity in your home only makes sense if you plan on eliminating other debt that has a higher interest rate.
When You Should Avoid Refinancing Your Home
Now, since you’ve discovered when it’s appropriate to refinance your home, we’re going to take a look at when it’s not a good idea to do so. First, if your credit score is in the poor sector, then you should hold off on refinancing. The truth is that you’re only going to be able to take advantage of the lower interest rates if you have a good credit score. Start by getting your credit score higher, then consider refinancing.
Realize that refinancing your home will cost you money to do so. These are considered closing costs and will be in the range of two to five percent of the new mortgage value. If you’re not paying cash for this upfront, you’ll want to ensure that you’ll be staying in your home for at least five years to recover the costs. Otherwise, you’re just going to be spending money on a new loan with no benefit if you sell.