Mortgage Refinancing - Reasons to Refinance

Homeowners choose to refinance for a wide variety of reasons. Some of the most popular ones are to:

Obtain a lower interest rate. Obtaining a lower mortgage interest rate can lower your monthly payment and is the most common reason homeowners refinance. Building equity faster is also a popular reason because owning a home can be one of the safest and most profitable investments you can make.

When you refinance to lower your interest rate, you can significantly reduce your monthly mortgage payment, so long as you don't increase your mortgage principal amount (as in a cash-out refinance).

It's important, however, to evaluate how long you plan to remain in your home. If you plan to stay in your home for several years, evaluate whether the cost savings resulting from a lower interest rate outweigh your refinancing fees. If you plan to sell your home in the near future, refinancing may not be your best option.
Build equity faster. You may want to build equity in your home more quickly than when you first obtained your mortgage. In this case, ask your loan officer about a mortgage with a shorter term. For example, if you have a 30-year mortgage, you may want to refinance to a 10-, 15- or 20-year mortgage and build equity faster.

This approach typically makes sense for homeowners who can afford an increase in their monthly mortgage payment. Each month, a certain part of the monthly payment goes toward the interest expense on the loan; the remainder is applied to the principal (some is also usually apportioned to escrow and taxes). Generally, the shorter a loan term, the higher the payment, but a greater percentage of that monthly payment is applied to the principal.

Change loan type. You may have selected an adjustable-rate mortgage (ARM) when mortgage interest rates were higher than rates today. To ensure you had the lowest monthly mortgage payment possible, you probably found the ARM most attractive because it had a lower interest rate than a fixed-rate loan in the early years.

When interest rates drop, however, refinancing to a fixed-rate loan can guarantee a lower rate for the life of the loan—as opposed to the interest rate on an ARM, which can adjust yearly or even twice a year, depending on the type of ARM you select.

Some financial institutions may offer ARMs with a "conversion period," which allows you to convert from an ARM to a fixed-rate mortgage, without refinancing.
Take advantage of an improved credit rating. Today, there are many ways for borrowers with impaired credit to get a mortgage. Typically, they may have to take out a mortgage with a higher interest rate than borrowers with a better credit history. But over time, these homeowners can improve their credit rating and choose to refinance to obtain a loan with different terms and a lower interest rate.

Refinancing may save you a significant amount each month, if you are now in a high interest rate loan that was the only type of loan offered to you because of your past credit.
Draw on equity already built in the home. If you're looking to tap into the equity you've built in your home, ask about a cash-out refinance. With this option, you receive cash at closing. Homeowners generally choose this type of refinancing to pay for their children's education, home improvements, debt consolidation or other needs.

A lender will typically require a homeowner to have at least 5% equity accumulated in the property for this type of refinancing. Equity is the difference between what the property is worth and the amount still owed on the mortgage. For example, if the house is valued at $100,000 and the mortgage balance is $90,000, the equity is $10,000 (10% of house value).

If you are considering a cash-out refinance for the added flexibility it may provide in helping you manage your expenses, first consider whether you will be getting your debt under control or increasing it.