When is it appropriate to refinance?
Generally you would consider refinancing in order to lower montly payments, lower interest rates or gain access to the cash equity in your home a current need such as necessary home improvements or to consolidate your bills. In order to decide when it is appropriate to refinance, a homeowner should evaluate the possible benefits and concerns.
Depending on the circumstances there are a variety of possible benefits, including:
Lower monthly payments
Often, when you have enough equity, you may refinance without any additional down payment and still lower your monthly payments. Also, refinancing under a different loan structure may result in reduced monthly payments.
Lower interest rates
Refinancing offers a number of options for lowering your interest rates:
1. Market interest rates may be generally lower inviting refinancing options before they rise again and the opportunity for locking in a low interest rate is gone
2. A special low-interest loan plan may be available
3. Your equity may be sufficient to allow for a restructuring of the interest plan (such as converting from an ARM to a low fixed rate mortgage)
4. Conversion of high-interest-rate debt (such as credit card debt) to low-interest-rate mortgage debt
5. Pay-down of a mortgage, providing options for better terms and less interest
Lower debt load
A lower debt load may simply offer less monthly stress and a greater peace of mind. But it may also allow for more of your money to go into investments or retirement funds. A lower mortgage balance may qualify you to drop your Private Mortgage Insurance. For future loans, an increase in equity may provide more flexibility in terms and options (such as rolling equity for a down payment).
Tax breaks on home improvements
Interest on second mortgages used for home improvements is generally tax deductible. Before deciding about a home improvement loan, a homeowner should consult with their accountant to determine the best tax advantages.
There are several ways in which restructuring debt may be advantageous. Some possibilities include:
1. Restructuring the payment plan (consider the bi-weekly mortgage plan which results in making an extra payment each year rather than the standard 12 monthly payments, reducing the total interest paid out and the loan life)
2. Restructuring payout terms (such as, switching a 30 year mortgage to a 15 year mortgage, which – depending on your equity position, type of loan, and terms – could result in some combination of lower interest, lower interest rates, reduced payment amounts, and a quicker building of equity and pay-down of your mortgage, or locking in an interest-rate option that could also reduce your interest, payments and loan length.
3. Restructuring the type of loan (possibly changing from an ARM to a fixed rate mortgage or from a seller-financed loan to a bank mortgage or adding on a second mortgage)
4. Restructuring the kind of debt (the proper balance of installment versus revolving loans affects your credit score)
Needed improvements, cash or other priority items
Refinancing can be the answer to funding those expenses that don’t fit into the on-going or monthly payment cycle. You can use your equity as the means to obtain funding, often without increasing your monthly payment, sometimes even reducing the payment and the interest. Although there are many reasons a homeowner considers refinancing, there are concerns that should be weighed into the decision, such as:
- Will the upfront costs outweigh the benefits?
- Will lower tax deduction due to decreased interest payments be advantageous?
- Will there be prepayment penalties?
- Will the long term and short term effects both be beneficial?
Your mortgage broker can help you weigh these factors and determine if, when and what kind of refinancing might be best for you.