You've had your home loan for a few years, your friends and neighbors have recently slashed their monthly mortgage payments through home refinance loans and now you're thinking about doing the same. Is mortgage refinancing going to save you as much as you think and why is now potentially the time to refinance?
Several reasons can exist as to why a homeowner would want a new loan. Most, but not all reasons are from a desire to lower monthly mortgage payments. Here's the most common reasons to refinance a home loan, with some you may not have considered, that can make your mortgage more flexible for your lifestyle and lower your monthly payments.
Reasons To Refinance A Home Loan and How You Can Benefit From Them
1. To take advantage of low interest rates and lower a mortgage payment for a fixed interest rate loan
This is the most common and easiest home finance method to save money on mortgage payments. A homeowner simply refinances a mortgage from a higher interest rate to a lower interest rate. But how much can you really save and when does it make sense to do this? Here's a simple refinance schedule chart;
| ||Original Loan ||New Loan - Various Financing Interest Rates |
|Interest rate ||7.50% ||7.00% ||6.50% ||6.00% ||5.50% |
|Loan amount ||$175,000 ||$170,240 ||$170,240 ||$170,240 ||$170,240 |
|Years remaining ||27 ||30 ||30 ||30 ||30 |
|Monthly payment ||$1,223 ||$1,132 ||$1,076 ||$1,020 ||$966 |
|Mthly payment savings ||----- ||$91 ||$147 ||$202 ||$257 |
|Total payments ||$396,454 ||$407,740 ||$387,372 ||$367,443 ||$347,977 |
|Total savings ||----- ||(-$11,285) ||$9,082 ||$29,011 ||$48,476 |
|Est. closing costs* ||----- ||$1,500 ||$1,500 ||$1,500 ||$1,500 |
|Months to breakeven ||----- ||17 ||11 ||8 ||6 |
* Mortgage closing costs could include government and third-party fees such as taxes, title fees and appraisal fees.
This example shows that refinancing a loan that has a 7.50% interest rate and 27 years remaining in it's term to an interest rate below 7.00% will save a homeowner money. Refinancing this loan at 7.00% will lower the monthly mortgage payment by $91.01 but the homeowner would pay $11,285 more over the term of the loan in addition to closing costs. Refinancing at an 6.50% interest rate or lower will drop the monthly mortgage payment by at least $147.59 and save upwards of $9,082 over the life of the loan.
2. Desire to increase a loans length to create smaller monthly payments
This method that you can use to lower your monthly mortgage payments on a fixed interest rate loan is to refinance and amortize a shorter duration loan into a longer duration loan. Refinancing a 15 year fixed mortgage to a 30 year fixed mortgage will lower your payments since the principal on the shorter loan will be amortized over a longer period through smaller payments. Homeowners should understand that this type of house refinancing will increase the total cost of the loan since more interest is accumulated over longer periods of time than shorter periods. Refinancing for a longer period is helpful if a homeowner needs to lower monthly household expenses and increase cash flow.
3. Lower monthly mortgage payments when a homeowner knows they will be moving from a residence
Refinancing a longer term loan to a shorter term loan at a lower interest rate will make sense when a homeowner has a general timeframe of when they will be moving from a house. Generally this will be financially prudent when a homeowner is moving in a minimum of 2-5 years, has a mortgage term several years beyond that timeframe and has a fixed rate loan and could benefit from an adjustable rate mortgage.
As an example, a 30 year fixed home mortgage loan with a 5.25% interest rate would have a monthly payment of $828. An 5/1 adjustable ARMs monthly payment would be $729 per month in the first 5 years with a 4.15% interest rate. By refinancing, if a homeowner was to move in 5 years, with the above example a homeowner would save $5,400 before paying closing costs to their refinancing company. Refinancing to an adjustable interest rate mortgage with a several year fixed interest rate can give substantial payment savings.
4. Eliminate potential increases in monthly payments from adjustable rate mortgage interest rate increases
Coping with potentially higher mortgage payments from an increase in an adjustable rate mortgages (ARMs) interest rate hike is often a reason for homeowners to refinance their ARM to a fixed rate mortgage with a locked in interest rate that won't ever change. Though refinancing to a fixed rate may increase a monthly payment, the increase will only happen once during the life of the loan and homeowners can chose whether that increase is acceptable or not.
Refinancing now could be especially important for homeowners who have an ARM that adjusts yearly and who believe that the current low interest rates will eventually rise.
5. Increase equity in a home quicker by paying principal sooner and lowering total interest expense
Refinancing a 30 year fixed mortgage loan to a 15 year fixed mortgage loan will save substantial amounts of money in interest payments and build home finance equity quicker. Here's a comparison;
| ||30 Yr. Loan ||15 Yr. Loan |
|Loan amount ||$140,000 ||$140,000 |
|Interest rate ||5.5% ||4.8% |
|Monthly payment ||$794 ||$1,092 |
|Monthly savings ||$297 ||---- |
|Total payments ||$196,664 ||$286,165 |
|Interest saved ||---- ||$89,501 |
|Equity after 10 yrs. ||$24,442 ||$81,821 |
This calculation clearly shows that a refinanced 15 year fixed mortgage would save $89,501 in interest expense and after ten years would have accumulated $57,358 more in home equity. Building home equity quicker with a 15 year mortgage could be important to a person planning for retirement that wants to payoff their mortgage at the date of retirement. People that desire to be debt free sooner could also chose to refinance their mortgage into a shorter duration loan.
6. To receive cash from refinancing to use for household expenses and other debt
Homeowners frequently refinance home loans to receive cash to buy a new car, go on a trip, pay off high interest credit cards, pay for college or for many other reasons. How does this cash out refinance work? An example would be a homeowner who owes $200,000 on a house that was purchased for $300,000. If the house was now worth $350,000, the homeowner could refinance for $250,000 and receive $150,000 in cash to use for other expenses. A homeowner could also save money during cash out refinancing if mortgage rates have fallen since receiving the original loan.
7. To get rid of private mortgage insurance (PMI)
When purchasing a home, if a home buyer puts a down payment that is less than 20% of a home's value for a home loan, the home buyer will be required to pay for private mortgage insurance to cover the lending bank or other lender for default on the loan if a home owner is eventually unable to make monthly payments. After an initial period of time, a home owner may desire to refinance their home loan if the combination of the principal paid and appreciation of a houses value exceeds 20% of it's purchase price. An appraisal will have to be completed before refinancing to determine a homes current market value.
8. Refinance a jumbo loan to a conforming loan
Currently a jumbo loan or non-conforming loan is defined by Freddie Mac and Fannie Mae as a mortgage that is in excess of $333,700. These loans have higher interest rates than conforming loans and home owners can benefit from refinancing a jumbo loan they've held for a few years if the principal owed on the loan is less than $333,701.
9. Shorten a mortgage loans length after achieving an increase in personal income
If your income has increased significantly over the past year or two and you wish to pay off your mortgage sooner, refinancing to a shorter loan amortization schedule with higher monthly payments may be desirable. The combination of lower refinancing rates offered for shorter length loans and the lowering of time in which money is borrowed will greatly reduce the amount of interest paid over the life of the loan.