Refinancing: is it for you?
January 2, 2021
Refinancing: is it for you?
You finally take the plunge and settle down in your new home, only to hear of people refinancing their mortgages. Now you’re wondering, “What does that even mean, and should I be doing it too?” Don’t worry - we’re here to give you all the information you need to decide whether it will be the right decision for you.
What is refinancing?
Refinancing is getting a new mortgage to replace your current one. Deciding to refinance means you will pay off an existing loan and trade it in for a new one. Refinancing can help you pay off your mortgage faster and help you save money, and build equity. There are two types of refinancing, rate and terms or cash out, so keep reading to see which one may apply to you.
The Two Types of Refinancing
Rate and terms refinance
A rate and term refinance changes just that - the rate and term of your mortgage. When choosing this type of refinancing, your new mortgage will either have a smaller interest rate, a shorter pay term (for example, decreasing from 30-years to 15-years), or potentially both.
Have you been in your home for a few years? Need your kitchen and master bathroom renovated? A cash-out refinance may just be the solution for you. A cash-out refinance is when you take out a new loan on your home for more money than what you owe on your current mortgage loan. Then, you are going to receive the difference in cash.
Why should I refinance?
Okay, we get the gist of what refinancing is. Now, why exactly do you refinance? Here are a couple of main reasons why it would make sense for someone to refinance their current mortgage.
- To obtain a better interest rate
Switching to a mortgage with a lower interest rate, which is considered a rate and term refinance, is arguably the most common reason to refinance your home. Let’s say interest rates suddenly drop dramatically - you may want to consider taking advantage of this and refinance. You can always refinance your remaining balance on your current mortgage for a new 30-year term at this lower rate, essentially lowering your monthly payments.
With this option, you will be paying less per month; however, you are basically starting your loan over from the beginning. If you had been paying your current 30-year term mortgage for 15 years, with 15-years left, and you chose to refinance, that is fine. Just be aware that your original plan to pay a 30-year mortgage just turned into a 45-year mortgage: fifteen years paying your existing mortgage, plus another 30 years after refinancing.
However, if your current financial situation entails needing to pay less per month, this option might be for you. Combining the lower interest rate plus the longer mortgage term will result in your monthly payments decreasing significantly.
People are going to tell you, “make sure your rate is going to lower by x% before refinancing!”. However, this is not necessarily the case for everyone. Just as humans are different, a person’s mortgage is too. If you are interested in finding out if this option is best for you, get a quote! It only takes a few minutes and could save you money!
2. To change the term of your mortgage
This option would be a rate and term type of refinancing. If your interest rate lowers, you may have the chance to change the term of your mortgage. If so, you can take this opportunity to refinance your current mortgage to replace it with a shorter term, without making much of a difference in your monthly payments.
Let’s use the same example as we did for a rate and term mortgage. Say you are 10-years into your 30-year mortgage, and you are taking advantage of these low interest rates and refinancing to a 15-year mortgage. Everything staying equal would increase your monthly payments by a significant amount, which no one is looking to do. However, since the interest rates fell, you could end up paying less per month for the remainder of your mortgage.
Even if your monthly payment is higher because of the shorter term, keep in mind you are still shortening your term. Since you already paid ten years of your mortgage and switched over to a 15-year term, that’s 5-years you are saving five years. For some people, the higher monthly payments may be worth it for a 25-year term instead of your existing 30-year mortgage. For some people, this isn’t worth it. That decision is up to you! As always, though, we are here to help in any way we can.
3. To tap into your equity
Okay, let’s set the scene. You’ve been in your current home for ten years. Your kids now have kids, so you’re going to need more space when they come to visit. It would be great if you could have an extra bedroom off the back, so the grandkids have their own room when they sleepover. The thing is, you’re only ten years into your 30-year mortgage term, and you don’t have that type of money to spend right now.
That’s where a cash-out refinance is going to come in handy. You’re going to be taking out a new mortgage for more money than your current loan, however you receive the cash difference so you can make those home renovations or send your child through college.
Does refinancing make sense for me?
The truth is, there isn’t a definite, universal answer for if you should refinance your mortgage. You need to look at your plans with your home and your financial state at the time.
With that being said, there are some general rules of thumb for when you’re considering refinancing. First, if you look at your current mortgage and decide you want to make it more desirable by obtaining a new interest rate. Second, make sure to do a break-even analysis. This will tell you if refinancing is something you can consider by confirming that you will be in your house long enough to benefit from the lower interest rate you will be getting by refinancing.
Insert formula for break even analysis
Now that we went through the basics of refinancing, you can weigh your options to see if this is the right step for you. The best way to figure this out is by chatting with a Broker and luckily for you, we're right here!