(FinancialHealth.net) – When a mortgage is refinanced, the lender issues a new loan with different terms to pay off the existing loan. There are a variety of reasons borrowers refinance, from lowering their interest rate to freeing up extra cash for a home renovation.
Refinancing isn’t a choice to be made lightly, since doing so can affect the future of your finances for the life of the loan. When does this choice make sense? There are a few times when you’ll want to sign on the dotted line.
Saves You Money
Refinancing can be used to lower the interest rate of an existing loan. It’s also possible to shorten the length of the loan, such as changing from a 30-year, fixed-rate mortgage to a 15-year term. The ultimate goal of this move is to save money, but it doesn’t always work out this way.
A fee is charged by the bank during refinancing, usually between 3% and 6% of the loan principal. These are typically known as closing costs. To determine if this expense is worth it, you need to calculate how long it will take to break even. When will the money saved on monthly payments cover what is spent on closing costs and then begin to pay you back? If it’s longer than you plan to stay in the home, it might not be worth it.
Financial Freedom
In some cases, refinancing a mortgage is a strategy for paying off personal debt. This isn’t a move to take lightly either, as it’s trading one debt for another.
Similar to the scenario above, it’s crucial that the borrower calculate if the money saved by eliminating the interest on personal debt will exceed the money spent on closing costs. It’s important to remember that paying off debt won’t fix poor spending habits — borrowers should only make this move if they’re certain they can avoid getting back into personal debt like credit cards.
Bad Move
It isn’t uncommon to use the equity in a home to cover the costs of large expenses like a remodel. This move may make sense if the home improvements will increase the value of the home enough to recoup the cost of refinancing down the road.
However, if the renovations won’t pay off enough to justify the expense, refinancing isn’t a good move. Opt for saving cash for projects instead.
If you’re not certain if refinancing is the right choice for your home, don’t be afraid to reach out for advice. A financial advisor can help determine if a new loan will pay off in the long term.
~Here’s to Your Financial Health!
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