A mortgage refinance means clearing all the existing debts with a new loan replacement. Homeowners do it for multiple reasons.
- Obtain low-interest rate
- Shorten mortgage term
- Convert from ARM [Adjustable-rate mortgage] to FRM [Fixed-rate mortgage]
- Convert FRM to ARM
- Tap home equity for financing a large purchase
- Consolidate debt
The cost of refinancing is around 3% to 6% on the principal loan amount [original loan amount]. It needs a title search, appraisal, and application fees. Therefore, homeowners need to decide if mortgage refinancing is a correct financial move in their situation.
Is it right or not to refinance for the following reasons?
Secure low rate of interest
The key reason for refinancing is lower interest rate on existing loans. It is a great step if interest rates can be lowered to a minimum of 2%. Borrowers can start exploring refinancing options on Sammamish Mortgage online. Decreasing interest rates helps to save cash, increase home-building equity and decrease monthly installment size.
For example, a 30-year FRM with a 9% interest rate on $150,000 as principal amount means you need to pay $1206.93 every month. If the loan gets refinanced at 4.5% then your monthly payments reduced to $760.03.
Shorten loan terms
Homeowners need to grab the opportunity when the rates of interest decline. Refinance existing one for another mortgage without changing monthly payments yet get a significant short term.
Using the above example, if interest rates drop from 9% to 5.8% then with a little monthly payment change from $1206.93 to $1249.63 the terms can be shortened to 15 years.
Conversion of ARM to FRM or vice versa
The interest rates of ARM and lower than FRM but periodic adjustments can cause higher rates than the rate you can get via a fixed-rate mortgage. If this occurs then conversion of ARM to FRM means low-interest rates and even the worries about a future hike in the rates get eliminated.
Alternatively, conversion from FRM to ARM is a sound financial move in a scene where interest rates are declining. It even removes the need to refinance whenever rates drop. This is not a wise move when mortgage interest rates rise.
Conversion from FRM to ARM means low monthly payments, which are great for homeowners, who plan to stay just for several years. Besides they don’t need to be concerned about future interest hikes!
Consolidate debt or tap home equity
The mortgage refinance move is a slippery slope for never-ending debt. Home equity is used to cover some key expenses like a child’s college education or renovation.
Homeowners justify their refinancing decision in the following ways:
- Remodeling adds value to their property.
- The loan’s interest rate is less than the rate of cash borrowed from a different source.
- Mortgage loan interest is tax-deductible.
These are justifiable arguments but increasing the term of the mortgage is not a wise financial move. Besides spending some dollars to get a 30% tax deduction on interest is also a bad idea.
Refinance to consolidate debt is a good move. It means replacing the high-interest mortgage with low-interest one. Unfortunately, refinancing will never bring financial prudence automatically. You will need to take steps to resist over-spending temptation as soon as you get relieved from the debt.
Refinancing can be a good move to control your debt, but needs a lot of prudence!