There are many reasons why refinance home loans are preferred by homeowners. They secure lower interest rates, reduce the loan’s term, convert ARMs to fixed-rate mortgages (or vice versa), tap into equity, consolidate debt, cash out existing home loans, and eliminate mortgage insurance. Refinancing a mortgage is the process of settling an existing loan on your home and applying for a new one.
Despite the fact that interest rates in the United States have been slowly creeping up, the current mortgage environment is still considered low-rate. According to figures released by the Federal Reserve Bank of St. Louis, the interest rate on a 30-years fixed rate mortgage is 4.04% on average, down from 6.07% a decade ago. Below is a closer look at 7 reasons why homeowners should consider refinancing their mortgages.
Reasons Why Refinance Home Loans
1. Securing Lower Interest Rate
Many homeowners follow the refinancing route in an effort to lower interest rates and save money on their monthly repayments. Historically, an interest rate reduction of at least 2% was enough of an incentive to refinance. Today, even a 1% reduction is enough incentive.
2. Reducing the Loan’s Term: Why Refinance Loans are Popular
Homeowners who are serious about paying off their mortgage faster should consider refinancing their 30-year mortgage to a 20-year, or even 10-year mortgage. While a shorter mortgage term means borrowers will pay slightly higher monthly payments, it also means they’ll enjoy lower interest rates and pay off their loan sooner. However, if rates have dropped since a homeowner bought a home, they may find there isn’t much of a difference in terms of the adjusted monthly payments.
But you don’t necessarily have to refinance to shorten your payoff period. Borrowers can also choose to make extra monthly payment to pay off their mortgage (without refinancing), but they won’t benefit from lower interest rates associated with shorter loan terms.
3. Converting an ARM to a Fixed-Rate Mortgage (or vice versa)
Adjustable Rate Mortgages (ARM) are home loans where the payable interest rate and monthly payments might fluctuate based on changing interest rate indexes like the COFI (Cost of Funds Index) ARMs start out by offering homeowners lower interest rates compared to fixed-rate mortgages, but periodic rate adjustments can lead to borrowers paying a higher rate than what is offered through a fixed-rate mortgage. When this happens, converting your ARM mortgage to a fixed-rate mortgage that locks in prevailing interest rates and eliminates future concern over interest rate hikes is recommended. Having a fixed-rate mortgage and not having to worry about future rate hikes contributes to why refinance home loans are becoming more popular among homeowners in the United States.
4. Tapping Into Equity
Home equity can be used to cover major expenses, such as extensive home renovation costs or your child’s college education. Homeowners who choose to refinance their mortgages for the benefit of tapping into their home equity justify this by pointing out that home renovation is a value adding initiative or the fact that interest earned on mortgages is tax-deductible.
5. Eliminating Mortgage Insurance
Homeowners with conventional mortgages and Federal Housing Administration (FHA) loans usually have to pay annual mortgage insurance premiums if they fail to put down asignificant down payment (10% for FHA loans and 20% for conventional). This adds to the overall cost of your mortgage and it’s logical why refinance loan lenders advise you to get rid of mortgage insurance as quickly as possible — you’ll save more money on your mortgage repayments in the long run. FHA loans require borrowers to carry mortgage insurance premiums for the duration of the loan. But if you have 25% and above equity in the home, you can refinance to a normal loan and eliminate these annual premiums from your mortgage. Even if your equity is below 25%, your payments will likely be lower in a non-FHA loan. Non-FHA loans also give borrowers the chance to stop making PMI payments when the loan to value ratio goes above 78%.
6. Consolidating Debt
Mortgage loans usually have lower interest rates compared to other types of loans. Home refinancing with the aim of consolidating debts is a major reason why refinancing loans are preferred by homeowners with high-interest debt. Borrowers can replace their high interest debts with low-interest mortgages to help get them out from under debt. If you’re currently servicing two mortgages, it’s almost certain that the second mortgage has a higher interest rate. After a probationary period that usually lasts 12 months, borrowers might be able to combine their two mortgages into one with a lower interest rate. You’ll also be eligible for a tax deduction on mortgage interest after consolidating your mortgages.
7. Cashing Out of an Existing Home Loan
Cash-out refinancing gives borrowers the chance to take out a new mortgage for more than what they owe allowing them to pocket the difference in cash. Homeowners can also use the cash to pay off outstanding debts. If you normally use cash to pay high-interest debts like personal loans, student loans, or credit card bills, you can reduce the amount of monthly debt repayments by refinancing these debts into your mortgage.
Why Refinance Home Loans: Conclusion
To sum it up, mortgage refinancing has many benefits but isn’t suited for every homeowner, especially if you don’t qualify for a better rate than what your current mortgage lender is offering. So find your own reasons why refinance home loans may be a good idea for you.
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