Lives can change in a short amount of time. It’s possible the situation you are in today could be drastically different than the situation you found yourself in just five years ago.
Maybe five years ago, you were fresh out of college, starting your career, single, and purchased your first home. Maybe today, you’re married with a two-year-old with another child on the way.
Or perhaps, you and your wife didn’t have a lot of income, money in the bank, or great credit scores. Since that time, though, maybe you’ve both gotten promotions, paid down your debt, stashed some money away, and significantly improved those credit scores.
Five years ago, your home could have fit your family’s needs — but now it could use some improvements you don’t have the cash to pay upfront.
These are but a few of the many examples of how your life could change dramatically in only a few years. Sometimes, when your life changes, so, too, does your financial situation.
In some of these situations, it’s possible that refinancing your home could address your financial needs by either lowering your monthly payment and mortgage term, providing you cash to fund home improvements, or giving you a way to consolidate other high-interest debt.
But how do you know when the right time to refinance is and the purposes for which it is best used?
What Is a Mortgage Refinance?
A refinance is (very simply) scrapping your old mortgage and replacing it with a new one.
At first glance, you might say, “I already paid five years of my mortgage down. Why would I want to start all over from scratch?” That’s a valid concern and a reason why you need to first assess the potential benefits of a refinance before diving in headfirst.
The crux behind a refinance is to get you out of the original mortgage you signed and into one better fits you current needs. Refinancing your mortgage could save you money in both the short and the long term by reducing your monthly payment and possibly even shortening the total length of the mortgage.
Refinancing could get you out of an adjustable rate mortgage and into a fixed-rate mortgage that will allow you to better predict your financial future, for example. Refinancing could also allow you to cash out, giving you funds to either pay down other debt or use for whatever you want.
Just like when you originally received your mortgage, a refinance will require you to provide information and supporting documentation that gives your lender the overall picture of your current financial situation. One of the benefits of refinancing is that your current financial situation may have improved significantly, allowing you to possibly qualify for a better rate or terms.
When Is It Best to Refinance? And Should You?
Generally speaking, the best time to refinance your mortgage is when your current financial picture is a lot better than it was when you signed your original loan. This may mean you have some combination of a higher income, less debt, a better debt-to-income ratio and a better credit score. All of these factors could result in you qualifying for a lower interest rate than you did originally, and possibly even a more advantageous loan type.
First-time homebuyers or buyers who didn’t have the greatest financial picture when they bought their home often benefit the most from this situation. If the interest rate on your mortgage was high because of your credit score, your payment is most likely higher than it would be today with an improved credit score. If you didn’t put at least a 20% down payment, you may have had to opt for an FHA loan or a loan that requires you to pay private mortgage insurance (PMI).
In both these cases, you could potentially save a lot of money on your monthly payment by refinancing, so you can lower your interest rate and/or change from an adjustable-rate to a fixed-rate mortgage. It’s even possible that you could shorten the remaining length of your mortgage by switching from a 30-year to a 15-year mortgage, depending on your situation.
Even with mortgage rates on the rise from where they were this time last year, they are still at historically low levels. Just a 0.25% difference in a mortgage interest rate could mean a noticeable difference in a monthly payment.
That could add up very quickly.
The other most advantageous time to refinance is if you have a good amount of equity in your home. This equity could be used for things such as debt consolidation, to pay for your kids’ college tuition, or for home improvements.
Refinancing your home would allow you to cash out all or part of that equity to use for whatever you’d like, as long as you qualify for a new mortgage. That money you cash out could be used for endless possibilities, including consolidating other higher-interest debts into one monthly payment.
Debt consolidation refinances are popular because they usually offer much lower interest rates than credit cards and other types of loans. Using the money you cash out in a refinance to pay off the credit card debt — by basically rolling it into your lower-interest mortgage — could save you a lot of money over the long haul while simplifying your life by reducing the number of monthly debt payments you have to make.
No matter what the reasoning behind your desire to refinance your home, it’s important to make sure the decision is smart both for the short and long term. Having a seasoned mortgage professional who is experienced in this area, like the experts at Embrace Home Loans, is essential to navigating the confusing waters of mortgage refinancing.