By Frank Gallo
There are many reasons to refinance: the opportunity to obtain a lower interest rate; the chance to shorten the term of the mortgage; the desire to convert from an adjustable to a fixed rate mortgage; the opportunity to tap a home’s equity in order to finance a large purchase; and the desire to consolidate debt. Some of these motivations have benefits and pitfalls. And because refinancing can cost 3% to 4% of the loan’s principal and requires appraisal, title search and other fees, it’s important for a homeowner to determine whether his or her reason for refinancing offers a true benefit.
With today’s rates many say 1% savings is enough of an incentive to refinance. Reducing your interest rate not only helps you save money, it also increases the speed at which you build equity in your home, and it can decrease the size of your monthly payment.
With today’s low interest rates, homeowners have the opportunity to refinance an existing loan for another loan that, with little change in the monthly payment, has a significantly shorter term, maybe shaving 5 to 10 years of mortgage payments.
While Adjustable Rate Mortgages (ARMs) often start out offering lower rates than fixed-rate mortgages, periodic adjustments often result in rate increases that are higher than the rate available through a fixed-rate mortgage. When this occurs, converting to a fixed-rate mortgage results in a lower interest rate and eliminates concern over future interest rate hikes.
Homeowners often access the equity in their homes to cover major expenses, such as the costs of home remodeling or a child’s education. Such a refinancing might be justified by the value that a remodeling adds to the home and by the lower interest rate on the mortgage loan than on money borrowed from another source. While these arguments may be true, increasing the number of years that you owe on your mortgage is rarely a smart financial decision.
Many homeowners refinance to consolidate their debt, replacing high-interest debt with a low-interest mortgage. Unfortunately, a large percentage of people who once generated high-interest debt on credit cards, cars and other purchases will simply do it again after the mortgage refinancing gives them more credit to do so.
Refinancing can be a great financial move if it reduces your mortgage payment, shortens the term of your loan or helps you build equity fast. When used carefully, it can also be a valuable tool in getting debt under control.
Before you refinance, take a careful look at your financial situation and ask yourself: How long do I plan to keep this property? And how much money will I save by refinancing? Again, keep in mind that refinancing costs at least 3% to 4% of the loan’s principal. It takes years to recoup that cost with the savings generated by a lower interest rate or a shorter term. So, if you are not planning to stay in the home for more than a few years, refinancing would not make sense. Also remember, that taking cash out of your equity when you refinance doesn’t help you reduce debt, build equity, or save money.
Frank Gallo is a licensed Mortgage Broker, NMLS 335384, that has being doing mortgages for over 20 years and can be reached at 818-637-2905