From refinancing to paying off credit card debt, we've got you covered
What is refinancing?
Refinancing your mortgage will allow you to pay off your current loan and replace it with a new one with a different term, monthly payment, and interest rate. With the ultimate goal of saving money, the various reasons why you, as a homeowner, would want to refinance your mortgage are: to pay off credit card debt; to get rid of PMI (private mortgage insurance); to increase long-term savings; and to refinance out of a Federal Housing Administration (FHA) loan.
Because refinancing your mortgage can cost up to 6% of your loan’s principal and requires a title search, appraisal, and application fees—the same process as with your initial mortgage—it is critical for you to figure out whether or not refinancing your mortgage is a wise decision financially.
Are you thinking of mortgage refinancing with bad credit? Here are some things you need to know.
To pay off your loan sooner
When you took out your initial mortgage, a term of 30 years might have made the most sense for you financially. However, securing a shorter-term loan—such as a 15-year mortgage, for example—could let you own a home sooner and build equity quicker, in the event that your financial situation has improved since you took out that 30-year term.
To pay off credit card debt
A great way to save more in the long term is to pay less interest on consumer debt like personal loans and credit cards. Typically, people consider paying off their debt with a cash-out refinance when thinking about refinancing to reduce interest on their consumer debts.
Whether or not this is a good or bad reason to refinance depends on you. For instance: it could mean that you end up with more debt than you began with if you do not have self-discipline, if your financial situation is unstable, or you do not have a multi-month emergency fund.
It is a possibility, if you have a lot of debt, that your debt-to-income ratio is too high or your credit score is too low to qualify for mortgage refinancing. It could also mean that you will not get the best mortgage rate.
To get rid of PMI
Private mortgage insurance, or PMI, costs you money each month. If you have 20% equity in your home on a conventional mortgage, however, you could request your lender cancel PMI—if you have a decent payment history, there are no liens against your home, you are current on your mortgage, and the original value of your home has not declined. As long as you are current, your lender will be required to cancel it after you reach 22% equity.
If you want to get rid of PMI more quickly, refinancing may be one route to take. It could be a costly way to get rid of PMI, however, since you will have to pay closing costs to refinance. Unless it is giving you other benefits—such as a lower interest rate, or if the break-even period is short enough—refinancing to get rid of PMI may not be worth the trouble. You will have to weigh the cost to refinance versus how much you will pay in PMI before your lender is willing to cancel.
It is also important to note that you can reach 20% equity in other ways than paying down your mortgage. You could potentially reach 20% equity if home values have increased in your market, giving you the option to get rid of PMI without needing to refinance. It’s true that you may still have to pay for a home appraisal, but it would still be quite a bit cheaper—and easier—than refinancing.
To convert to an ARM or fixed-rate mortgage
An adjustable-rate mortgage (ARM) might begin offering lower rates than fixed-rate mortgages, but adjustments throughout the term could result in increases that are ultimately higher than a fixed-rate. If you run into this, converting from an ARM to a fixed-rate mortgage could result in a cheaper interest rate, eliminating the stress of potential future rate hikes.
On the other hand, since an ARM often offers lower monthly payments, converting from a fixed-rate mortgage to an ARM might be a good strategy financially if interest rates are dropping. This scenario is especially relevant if you are a homeowner who is not planning to stay in your house for more than a few years.
To increase long-term savings
There are two ways that refinancing your mortgage can help you increase long-term savings: paying less each month will give you the opportunity to save and invest more for retirement now, even if it means paying your mortgage for a longer period; and a lower interest rate could lessen the interest you pay on your mortgage over the duration of your loan.
The first of these options is riskier. If you are younger when you save and invest for retirement, you will have more opportunity for years of compound returns to accumulate, which could be much more than the interest you would save after you pay down your mortgage faster. It is important to remember, however, that investment returns are never a guarantee. The second option is more of a sure thing. You will pay less interest the faster you pay off your house and the lower your mortgage interest rate is. Remember: closing costs for the mortgages you take out are also a portion of your long-term borrowing costs.
To lower your monthly mortgage payment
Your monthly mortgage payment will be impacted with even the smallest difference in your mortgage rate. Your monthly payments will almost definitely shrink if you refinance to a lower interest rate, freeing you to put those savings towards applying to your principal balance, helping you to pay off your loan more quickly or take care of other expenses.
