Why refinance a house? Does it make financial sense to you?

Are you wondering, why refinance a house? Well, refinancing can make good financial sense if it brings down your mortgage payment, shortens your loan term, or helps you build home equity more quickly. 

It can also be a valuable tool for managing your debt better. 

However, before refinancing your home, you must carefully look at your financial situation and ask yourself, how much money will you be saving by refinancing? Do keep in mind that the refinancing closing cost is about 3% to 6% of the loan’s principal amount. And, it takes considerable time to recoup that cost with the savings that come with a lower interest rate or a shorter term. 

Therefore, to get the most out of your refinancing, you’ll need to stay in the house for more than a few years. Otherwise, taking cash out of your equity when you refinance may not help you achieve financial goals such as reducing debt, building equity, or saving money.

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What does refinancing a house mean?

To refinance a mortgage refers to replacing your existing home mortgage with a new one that offers better mortgage rates. The new loan type may have different loan terms. For example, a 15-year term instead of a 30-year term. Or, a more predictable fixed-rate mortgage (FRM) instead of the earlier adjustable-rate mortgage (ARM). However, the most common reason a homeowner thinks of refinancing is to get lower interest rates. 

They can lower the monthly mortgage payments, save money on the total interest over the life of the loan, pay off the mortgage loan sooner, and draw cash off the equity in the home.

How does refinancing a mortgage work?

Applying for refinancing is similar to applying for a mortgage when buying a home. A mortgage lender will review your finances and credit score, and assess your level of risk to determine your loan eligibility. The most financially strong borrowers generally get the most favorable interest rates. 

Since it’s an entirely new loan, it could be with a different lender than the one who worked with you at the time of buying your house.

Also, you can reset your repayment schedule with refinancing. For example, let’s say you have already made five years of payments on your existing 30-year mortgage, you may be able to refinance into a new 20-year loan instead of refinancing to a new 30-year loan. This arrangement will help you pay your loan off earlier.

But also keep in mind that you’ll have to factor in the closing costs which include discount points, loan origination fees, and an appraisal fee. 

That’s why it’s important to compute the break-even point. That is to say, you’ll need to assess whether you’re staying in your house long enough to repay the high closing costs and enjoy the refinance savings. Otherwise, refinancing is not worth opting for. 

Why refinance a house: Common reasons

You may be wondering why to refinance a house because it does involve some legwork, extra paperwork, and additional costs. But, there are various good reasons to invest your time and money in a refinance. These include:

• Lower interest rate: The most common reason for refinancing is that it offers you a chance to lower your interest rate. Regardless of the fact that your credit score may have improved since your original mortgage or the market may have changed, a lower interest rate can help you save money over the course of the loan. 
• Access to a different loan type: A new loan gives you many options and may be better for your finances. For example, you may want to replace an uncertain adjustable-rate mortgage with a stable fixed-rate mortgage. Or, you could switch to a conventional mortgage in order to discontinue paying FHA mortgage insurance. 
• A chance to utilize home equity to borrow more money: Sometimes, refinancing may give you access to more funds. For example, you can leverage the equity in your home to borrow a bigger sum of money through cash-out refinancing. That way, you may be able to fund a big-ticket purchase, a home improvement project, or a college education.
• An opportunity to shorten the loan term: If you have 20 years left on a 30-year mortgage, you could opt for a new 15-year loan instead. Of course, your monthly payments will go up, but you’ll end up paying back the loan amount faster.

What are the pros and cons of refinancing a mortgage?

It’s a good idea to make a list of the benefits and drawbacks of refinancing to determine whether it’s the best option for you, or not.

Pros

• Lower interest rate and bigger savings.
• A chance to lower your mortgage payment and manage your monthly budget better.
• The option to decrease the term of your loan and pay it off sooner.
• Tapping into your home’s equity for more cash.
• An easy way to consolidate debt such as a student loan or a credit card debt into one single payment.
• An opportunity to change from an adjustable-rate to a fixed-rate mortgage. Or, vice versa.
• This is a good way to avoid paying private mortgage insurance premiums and unnecessary fees.

Cons

• The high closing cost of refinancing.
• Shifting to a longer loan term will add to your costs and delay your home loan payoff date.
• A cash-out refinance will leave you with less equity. 
• There’s always a chance that market interest rates will drop after you close.
• The refinancing process takes between 15 and 45 days to complete.
• Your credit score will take a hit temporarily.

Read more: Home loan information

How does refinancing affect my credit score?

Your credit may be slightly impacted by refinancing a mortgage, but this effect is typically minimal and temporary. Some of the reasons your score takes a hit are:

• Mortgage lenders do a credit check on you to see whether you qualify for refinancing or not. This hard check appears on your credit report and may decrease your score by up to five points.
• Your credit will go down if you apply for an additional loan such as a car loan or a credit card.
• Closing one loan to open another may affect your credit history – which makes up 15 percent of your total score.

If you don’t want to hurt your score while comparing refinance offers, it’s a good idea to shop for loans within a 45-day window to ensure that the credit pulls count as one inquiry.

Last thoughts

It can be a wise financial decision to refinance. If you want to stay in your house for a long time, a reduction in interest rates can significantly improve your financial situation. The following points will not leave you asking, why refinance my house?

• There’s a good chance that you get a mortgage with a lower interest rate.
• You may be able to shorten your mortgage term and pay significantly less in interest payments.
• You could switch to a more stable fixed-rate mortgage.
• Or, tap into your equity for debt consolidation. 

If you can choose the right time to refinance your mortgage, you can save a good sum of money.

Read more: How soon pull equity out of home

Written by Ramona Sinha. November 3, 2022

Ramona is a content writer for Kukun. This experienced blogger uses simple and succinct words to decipher the complex phenomenon called life. An avid traveler, she’s a digital nomad at heart and an animal lover from the depths of her soul.