The terms of a mortgage have a profound impact on the overall cost of home ownership. Refinancing is a process where a borrower is able to alter the terms of a loan by allowing a lender to pay off his current loan in exchange for a new one. Whether it is worth it to refinance will depend on your specific financial situation, but there are several scenarios where refinancing can be advantageous.
Low Interest Rates
One of the primary reasons people refinance mortgages is to save money by taking advantage of low interest rates. If interest rates have fallen since you took out your original loan, you will likely be able to get a lower interest rate by refinancing. Seemingly small differences in interest rates can result in significant savings. For instance, if you have a $300,000 mortgage, shaving 1 percentage point off your interest rate can save you thousands of dollars each year.
Changing to a Fixed Rate
Mortgages can have fixed or adjustable interest rates. Fixed-rate mortgages have interest rates that stay the same for the life of the mortgage. Adjustable-rate mortgages have rates that change over time based on current interest rates. If interest rates are low, it may be worth it to refinance an adjustable rate mortgage to a fixed rate mortgage to lock in at a low rate and avoid the possibility of rate hikes in the future.
Changing your Mortgage Term
Another situation where refinancing may benefit you is if you want to adjust your mortgage term. Mortgages usually have a term of 15 to 30 years. Shorter mortgages usually have lower interest rates but monthly payments are higher. If you wish to reduce your interest rate and build equity faster, you might benefit from refinancing from a 30-year loan to a 15-year loan. On the other hand, if you are having difficulty making payments on a 15-year loan, refinancing to a 30-year loan can make it easier to afford monthly payments.
Tapping Into Home Equity
When you refinance you can elect to borrow more than the amount of your current mortgage balance and receive cash for the additional amount borrowed. This is called "cash-out refinancing." This may allow you to pay for certain expenses that you would not be able to afford with your savings, such as unexpected medical expenses or a child's tuition.
Considerations
Refinancing can be a costly process. The Federal Reserve Board states that refinancing costs can exceed 3 percent of the total value of a home. Refinancing is only worth it if the benefits you receive exceed the cost of refinancing fees.
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