Refinancing a home can reduce mortgage payments, offer rate stability, unlock equity and consolidate debt to improve financial health.
Are you having trouble making your monthly mortgage payment or balancing debt and home insurance bills? For some people, refinancing their home mortgage might be the path back to financial stability.
“The benefits of refinancing your home include lowering your monthly payments, removing private mortgage insurance, paying out high interest credit card debt (on a cash-out refinance) and getting funds for a home improvement,” says Reed Letson, owner of Elevation Mortgage.
While it’s important to learn the benefits of refinancing, you should also be aware of some associated risks. “One thing to keep in mind is most lenders will reset your loan term back to 30 years,” Letson says.
Read on to learn the benefits of refinancing and some things to keep in the back of your mind.
Benefit 1: You Might Be Able to Secure a Lower Interest Rate
If interest rates are lower now than when you bought your home, you can often save thousands of dollars by refinancing. When you refinance your loan, you lock into today’s interest rates. Reducing what you pay in interest by even a fraction of a percent can save you a lot of money by the time you finish paying off your home.
For example, let’s say you have a loan with a principal balance of $150,000, 20 years left on your term and an APR (annual percentage rate) of 4%. Now, imagine that today’s rates are around 3.5%. If you refinance your loan to today’s interest rate, you’ll pay $58,785.50 in interest by the time you pay off your loan. If you don’t refinance, you’ll pay $68,152.95. This means that by refinancing to a rate that’s just half a percentage point lower, you save over $9,300 by the time you own your home.
Mortgage interest rates change daily. Know your interest rate and monitor how rates change in your area. This can help you refinance when rates are lowest – and save you the most money possible.
Benefit 2: Refinancing Allows You to Customize Your Mortgage Payment
One of the most common reasons you may want to refinance your mortgage is to lower your monthly payment. When you refinance for a longer term, you lower the amount you need to pay your mortgage company monthly. Lengthening your term results in paying more interest by the time you own your home, but it can be an excellent solution to help you stay in your home if you lose your job or encounter an unexpected medical bill.
You can also shorten your mortgage term and take on a higher payment. When you shorten your mortgage term, your monthly payment will significantly increase. However, you’ll own your home sooner and often save tens of thousands of dollars in interest. Shortening your mortgage term can be ideal if you’re now earning more money than you were when you bought your home.
Benefit 3: You Can Use Your Home Equity to Pay Off Debt
If you have outstanding debt accumulating interest, you can save money and free yourself from additional interest accumulation by getting money via your home equity through a method known as cash-out refinancing.
A cash-out refinance is a special mortgage refinance that allows you to access your home equity. Equity refers to the percentage of your home that you own. Every time you make a mortgage payment, you build equity in your property by paying down your principal loan balance. You accept a higher principal loan balance with a cash-out refinance, and your lender gives you the difference in cash.
RELATED: Cash-Out Refinance vs. HELOC
Cash-out refinances are useful because mortgage loans offer one of the most affordable ways to borrow money. The average 30-year mortgage loan has an APR between 4% and 5%, while the average credit card has an APR of over 17%. When you take a cash-out refinance, you can pay down your high-interest debt and replace it with debt on your much more affordable home loan. This can save you thousands of dollars when you finally pay off your home.
Benefit 4: Get Rid of Mortgage Insurance
Lenders typically require mortgage insurance when homebuyers make a down payment of less than 20% of the home's purchase price. If your home has appreciated since you originally purchased it, you may now have enough equity to meet the 20% threshold that allows you to avoid mortgage insurance on the new loan.
Refinancing could enable you to switch from an FHA or USDA loan, which requires mortgage insurance for the life of the loan, to a conventional loan that allows you to eventually cancel mortgage insurance once you reach 20% equity.
Benefit 5: Secure Funding for Home Improvement
By refinancing, you can tap into your home's equity, which is the difference between the home's value and the outstanding balance on the mortgage. The new mortgage loan can be structured to provide additional cash beyond what is needed to pay off the old mortgage. The refinanced loan's "cash-out" portion can be used for various purposes, including funding home improvement projects or necessary repairs.
The cash-out refinance option is particularly advantageous if you have built up substantial equity in your home through mortgage payments and property value appreciation. By accessing this equity, you can obtain funds for renovations or upgrades without taking out a separate loan or depleting your savings. The money obtained through a cash-out refinance can finance major projects such as kitchen or bathroom remodels, additions or structural repairs, enhancing the home's value and improving overall living conditions.
It is advisable to have a clear plan for home improvement or repair projects to ensure that the funds are utilized effectively and contribute to the long-term value and functionality of the home.
Risks of Refinancing
While Letson says some lenders will return you to a 30-year mortgage regardless of how long your loan is remaining, some can set custom terms.
“For example, if you have been in your home for three years and you are looking to refinance for a lower payment, we can set the loan term to 27 years instead of 30,” he says. “This allows you to really compare the monthly payment to see how much you are really saving each month.”
Another risk of refinancing is doing so when interest rates are higher than when you first closed on the loan.
The Bottom Line
The benefits of refinancing include locking in a lower interest rate, negotiating a new payment schedule, using equity to pay off debt or other unexpected costs, eliminating private mortgage insurance and securing money for renovations through a cash-out refinance. Don’t refinance your house if interest rates exceed your original home loan.
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who has won awards for his New York City economy coverage. He has navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
For this story, we worked with Jose Garcia, president and CEO of the Illinois-based Northwest Community Credit Union, which offers multiple financial services, including mortgages.
Frequently Asked Questions
Is there a benefit to refinancing?
The five main benefits of refinancing are securing a lower interest rate, negotiating a different payment schedule, getting funds via home equity, eliminating private mortgage insurance and paying for renovations through a cash-out refinance.
What are the cons of refinancing?
One con of refinancing is that it could extend your deal back to 30 years, no matter how far along you are in your existing home loan. Refinancing could also harm you if the Prime interest rate is higher than your mortgage.
Can refinancing hurt your credit?
Because lenders have to make a hard credit inquiry when you apply for refinancing, there might be some short-term harm to your credit score. The goal, however, is to negotiate a more favorable deal so that you can make timely payments and work on improving your creditworthiness.
Sources
- Jose Garcia, president and CEO of Northwest Community Credit Union
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.