Refinancing your mortgage can be a financially empowering move. By refinancing, you pay off your existing mortgage and replace it with a new one. Homeowners refinance for a variety of reasons:
- To obtain a lower interest rate
- To shorten their mortgage term
- To convert an adjustable-rate mortgage (ARM) into a fixed-rate mortgage
- To cash in on home equity, which can be used to raise funds for financial emergencies, large purchases, or debt consolidation
In addition to an appraisal and title search, refinancing can cost between 2% and 5% of the loan’s principal. Because refinancing is far from free, homeowners should consider whether refinancing is a wise investment before they commit.
Mortgage Refinancing: How Does it Work?
A refinance is similar to getting a mortgage to purchase a home. There’s less pressure to close by a specific date this time around, so you can be relaxed about home buying and moving. Your existing mortgage will be paid off when you refinance, and you can usually cancel your loan within three business days after it closes if you end up regretting your decision.
When is the Best Time to Refinance?
Before refinancing, make sure you meet the requirements—and remember to consider the value of your home, interest rates in your area, the refinance process, and how frequently you can refinance. Other than that, two particular circumstances are ideal for refinancing; let’s take a look.
When Your Credit Score Increases
A higher credit score when applying for a loan will give you a better chance of qualifying. An individual’s credit score reflects how well they manage their debt.
A high score means you always make your loan payments and don’t borrow too much. Alternatively, a low score suggests you are having trouble handling your debt, either by missing payments, having too many accounts open, or carrying more debt than is reasonable on your income.
Mortgages are forms of debt. Lenders use credit scores to determine your reliability as a borrower before they offer you an interest rate because statistics show that people with higher credit scores are less likely to default on their payments or fall into foreclosure.
When your credit score is high, lenders can give you a lower interest rate because they assume less risk when lending you money. However, a low credit score might mean you cannot repay what you borrow, so your lender must charge you a higher interest rate to manage the risk they accept.
Your credit score increases when you make your mortgage payments on time. However, your credit score might surprise you if you last checked it a while ago. Check your numbers against your score at the time you got your loan. It might be worth refinancing if your score has risen significantly since you applied.
During a Low Interest Rate Environment
When interest rates on home loans drop significantly, it is an excellent time to reevaluate your mortgage. Otherwise, you might end up paying a lot for your home based on your interest rate.
If you had locked in a mortgage during a high rate period, you might have been paying too much. You might save money if you refinance into a loan with a lower rate. It can save you thousands of dollars to eliminate just a few tenths of a percent off your interest rate.
Refinancing your mortgage can make real financial sense, and many people use this method to save on interest and access cash. However, always check with your financial advisor and lender before making a significant financial decision!