Should You Refinance Your Home?

If you are a homeowner, chances are you’ve received emails or physical mail advising you to refinance your mortgage, but many Americans don’t understand exactly what this process entails. Before taking the leap, learn more about what it means to refinance your loan and whether or not it’s right for you.

What is refinancing?

Put in simple terms, refinancing a loan means paying it off and replacing it with another one. That means you could end up with a lower interest rate than you had on your initial mortgage, as well as a shorter term. Investopedia.com also mentions that refinancing might make sense for borrowers with an adjustable-rate mortgage who want to lock in a lower, fixed interest rate on their loan.

Reasons to refinance

Mortgage rates are at an all-time low.  Many people are pursuing refinances but there are other options for you to consider if you need cash for a home improvement, college tuition, or debt consolidation.  If you own your home, there are several home loan programs that may work for you:

• Rate/Term Refinance - This one relates to the desire to save money on an existing loan.  Rate/term refinances are a great way to take advantage of lower interest rates. This option makes sense if you can find a loan at a lower interest rate than your current one and at a term you can afford.  It is important to calculate your “break-even point,” which is the time it will take for the mortgage refinance to pay for itself.  Divide the total closing costs of your new loan by the total amount you’ll be saving per month to see your break-even point. For example, if you paid $3,000 in closing costs and will save $100 per month with your new loan, it’ll take you 30 months, or 2 and a half years, to start seeing gains.

• Cash out refinance - In this scenario, you would take out a new mortgage for more than you currently owe on your house. This allows you to pocket the difference and use the money how you see fit, such as to pay off other loans.  Basically, homeowners choose cash out refinances so they can turn some of the equity they've built up in their home into cash.

Be aware that there can be restrictions to cash out refinances.  A few common ones are a minium credit score, a maximum loan to value and something called a "seasoning requirement" which can mandate that you have occupied your home for a certain time period before you apply for a cash out refinance.

• Loan Modification - Like a rate/term refinance, a loan modification won't allow for maximum cash out but can lower your interest rate with a flat rate fee rather than closing costs.