July 21, 2020
July 21, 2020
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Mortgage refinancing refers to the replacement of an existing mortgage with a new one. There are many reasons why homeowners choose to refinance, such as obtaining a lower interest rate, reducing the length of the term, lowering interest payments, consolidate debt, cover an emergency expense or finance a large purchase such as home renovation project.
While the reasons vary from borrower to borrower, refinancing can save you thousands on your mortgage and help you achieve your life’s goals sooner. When done right it can be a savvy financial move. However, it is an important decision to make and doesn’t make sense for everyone. In this article we will dive deeper into when it makes sense to refinance and how it can benefit you in the long-run.
One of the best reasons to refinance is to secure a lower interest rate on your existing mortgage. Typically, refinancing is a good idea if you can lower your interest rate by 2%, but many lenders say 1% savings is enough of an incentive to do so.
Lowering your interest rate does not impact your principal loan amount but it can lower monthly interest payments. You could potentially save thousands over the life of the loan, helping you build equity in your home faster and pay off your loan amount sooner.
For example, a 30-year fixed-rate mortgage with an interest rate of 5.5% on a $100,000 home has a principal and interest payment of $568. That same loan at 4.1% reduces your payment to $483. It may not seem like a big savings, but over a 30-year term the amount saved in interest alone is substantial.
Typically, it only makes sense to refinance when you are planning on living in the home for a longer period of time. The reason is that most refinances take several months or even sometimes years to breakeven and start saving money. There are closing costs such as title insurance, attorney fees, home appraisal costs, transfer fees, taxes etc. that are associated with mortgage refinancing. So, it may not be worth it to incur such fees if the borrower is only planning on staying in the home for a few more months.
You can determine what your breakeven point is by using a simple calculation. In the example above, if the new loan saves you $5,000 per year, then the monthly savings would be $417. If closing costs totaled $4,170 then you can simply divide 4,170 by 417 = 10 months to break even. If you, as the borrower, are planning to sell the house before 10 months then it would not make sense to refinance. But, it’s not always that simple. A Mortgage Broker can help you determine if it’s a wise choice for you.
Homeowners often choose to refinance a mortgage to tap into equity they have accumulated through mortgage repayment. There are several ways to do this: a second mortgage, HELOC (Home Equity Line of Credit) or by breaking the mortgage which is the less favourable as you would incur hefty penalties.
A second mortgage is an additional loan taken out on a property that is already mortgaged. More homeowners are taking out second mortgages on their property to access equity without being forced to sell or pay a huge penalty when breaking the existing mortgage.
Another popular alternative is a Home Equity Line of Credit. A HELOC is a revolving line of credit that is secured against your property. The loan amount you are approved for is a direct reflection of the equity available in your home, as verified by an appraisal. If the borrower does not have strong credit and cannot qualify for a HELOC through an institutional lender like a bank, then a private lender would be required to obtain a second mortgage.
A HELOC has a unique advantage in that it can be used, repaid, and used again, while only paying interest on the portion of the funds that have been used. A HELOC is a good solution for many financing needs such as launching or supporting a small business, covering medical and health expenses, accessing funds for purchasing a second property, financing home renovations, repairs, construction and other household projects.
Another reason why homeowners choose to refinance is to shorten the amortization or the length of their mortgage loan. Refinancing can reduce your amortization from 25 years to 10, 15 or even 20 years. By reducing the length of the mortgage term, borrowers will pay less interest over the life of the loan. However, by doing so, monthly payments will increase unless the borrower adds a large lump sum to the mortgage prior to refinancing.
For example, if you recently got promoted into a job with a higher salary, you may be able to afford higher cash outflow every month, whereas before you would not be able to do so. This is a decision based on everyone’s unique financial profile and whether the borrower can afford a new, higher monthly payment while balancing other expenses.
Many homeowners refinance to consolidate debt and pay off high-interest loans. After building up some equity in your home, homeowners can access up to 80% of home’s equity to pay debt that has a higher interest rate than their mortgage. You can tap into home equity to access funds to pay credit card debt, car leases and car loans, student loans or other high interest debts, thus reducing monthly interest payments and increasing overall cash flow.
A debt consolidation mortgage combines your debts and your mortgage principal allowing you to worry about only one monthly payment at a much lower interest rate. Debt consolidation mortgages come with a structured payment plan and an assured pay-off date. Payment schedules vary depending on your agreement.
High interest debts such as credit cards and loans have a significantly higher interest rate than a mortgage. If you own your home, tacking on high interest debt to your mortgage principal can be a good way to shave down any outstanding balances while saving money, increasing cash-flow and improving your credit score.
The bottom line is mortgage refinancing can be a great move if it reduces your mortgage payment, shortens the term of your loan, or helps you build more equity. When planned strategically and used carefully, it can be a valuable tool to bringing high-interest debt under control or help you achieve life’s goals sooner.
However, before you refinance you need to think about whether you are the right candidate. Take a careful look at your financial situation and ask yourself: How long do I plan on living in my house? How much money will I save by refinancing? What do I want to use the money for? How will it benefit me or impact my life?
Pursing a mortgage refinance is an important financial decision that can save you thousands if done right. Your home is one of your biggest assets. As a savvy homeowner, can use your house to achieve your life’s goals and achieve financial freedom faster than you would otherwise.
Talk to one of our experienced mortgage advisors today about whether mortgage refinancing is right for you.
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