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Four Smart Reasons to Refinance Your Home Mortgage

January 8, 2021 By: Great Midwest Bank

If you’re reading this, you’re probably a homeowner doing your research on refinancing a home mortgage. It’s been the topic of many news stories of late. So, should you be considering it too? There are many situations in which refinancing your mortgage may be right for you. We’ll go over four smart reasons to refinance your home mortgage but first let’s define what refinancing a mortgage means.

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What is refinancing a mortgage?

When you refinance your current home mortgage, you’re basically swapping out your old loan for a new one. However, there are two main types of refinances:

Rate-and-term refinance

The remaining balance on your current mortgage is transformed into a new loan that has a better rate and/or term for your situation.

Cash-out refinance

You liquidate some of your home’s equity, creating a new loan that consists of your previous mortgage balance plus the cash you took out. See an example here.

Now, you can refinance your home mortgage with any mortgage lender you choose, including your current lender. However, we encourage you to shop around when refinancing and consider a community bank such as Great Midwest Bank

Reasons to refinance your mortgage

So, why are so many homeowners refinancing in the first place? Great question. The answer all depends on your goals. People choose to refinance for a number of reasons, but here are four of the most common motivators for homeowners.

1. You want to lower your monthly payments

If rates have dropped since you got your original mortgage, you may be able to refinance into a loan with a lower rate. Doing so may lower your monthly payments, meaning you may also pay less over the life of your loan. To find out if you stand to save on your monthly payments, you can check today’s rates in seconds.

Alternatively, if rates haven’t dropped significantly but you anticipate a decrease in income, you may be able to lengthen your loan term to pay off your loan more gradually. 

For example, if you switch from a 15-year fixed-rate mortgage into a 30-year fixed-rate mortgage, you can lower your monthly payments. It’s important to note that you’ll be paying interest for a longer period of time.

If interest rates have dropped since getting your home mortgage,
you may be able to refinance into a loan with a lower rate.

If you’ve paid off a significant amount of your mortgage and/or the value of your home has increased, then your loan-to-value ratio (LTV) will be smaller. A smaller loan amount compared to the value of your home means that the loan is considered lower risk to the lender. This can help you get a better rate. Have you been paying for private mortgage insurance? If you’ve passed the 20% mark for equity, you can refinance to cancel your mortgage insurance.

2. Refinance if your credit score has improved

Improving your credit score has many benefits you take advantage of including being able to refinance your home mortgage to get a better rate. For example, depending on the specifics of the loan, a 20-point bump in your credit score could save you thousands of dollars by reducing your rate.

It’s a good idea to regularly monitor your credit score so you have a good idea of where it stands and when you might have enough leverage to refinance for a lower rate.

Paying bills on time and lowering your overall credit utilization are just a couple ways you can improve your credit score.

3. Refinance if you want to consolidate debt

Refinance to consolidate other debts into a single, more affordable payment. This is especially helpful if you have high-interest credit card debt, student loans, or a second mortgage. This type of refinance is considered a cash-out refinance. It means a portion of your home equity is turned into cash that you then use to pay off other loans and debts. Your old mortgage will be replaced by a new one that includes the amount you took out to pay those other debts.

Because of the difference in credit card and mortgage interest rates, consolidating credit card debt in this way can save you a considerable amount of money. As of May 2020, the average credit card interest rate in the U.S. is 14.52%. At the same time, mortgage rates are hitting historic lows. By moving your credit card debt to your mortgage, you may be able to save a significant amount from the lower interest rate in the long term. Better yet, mortgage interest is usually tax-deductible. 

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4. Refinance if you want to take cash out

Doing a cash-out refinance allows you to use the equity you’ve built in your home to borrow money. Homeowners often reinvest that cash out back into their home by making home renovations or repairs that boost their home’s value. Taking cash out can also be useful if you need extra money for expenses such as education or medical costs and don’t have access to other funds.

How exactly does a cash-out refinance work? Well, let’s say your home is worth $300,000 and you have $100,000 left on your current mortgage. That means you have $200,000 in home equity that you can borrow against. If you could choose to do a cash-out refinance for $30,000 of your equity, your new mortgage would be for $130,000.

Since lenders view cash-out refinances as riskier than rate-and-term refinances, interest rates are generally higher. You may still be able to get a better interest rate than your current financing, particularly if rates have dropped or your credit score has improved. Most lenders also require that your loan-to-value ratio (LTV) stays at or below 80% post-refinance (for a single-unit primary residence).

Is refinancing a good idea for you?

There can be many benefits to refinancing but it’s important to remember that you’ll still have to complete a loan application and pay closing costs. It’s a similar process to when you got your original mortgage and you’ll likely have to pay for lender fees, appraisal fees, and title insurance fees. 

If you’re looking to get a better rate or term by refinancing, then first consider your break-even point. It’s the length of time it takes you to recoup the costs of refinancing. If you’re planning to remain in your current home beyond the break-even point, then it might be a good idea to refinance your mortgage. 

If you only plan to keep the home for a few more years, you may want to consider what’s called a “no-cost” refinance, where you offset your closing costs by raising your refinance rate (i.e. taking credits). For a cash-out or debt consolidation refinance, you should also compare the benefit of how you’ll be using the money you take from your equity against the added time (and interest) it may take to pay off the loan.

Run the numbers

Let Great Midwest Bank check your break-even point and how much you can save by refinancing. Our experienced loan officers will help you see the breakdown of all the costs associated with your refinance depending on which loan options you are considering.

If you’re considering refinancing your mortgage, the first move is to figure out your goals. Knowing what kind of refinance you’re looking for will help you compare rates and estimates. So, if you want to learn more about refinancing or you’re ready to get started, contact one of our local loan officers today. We’ll take the time to go over all the different options so you feel good about taking the next step.