Mortgages are a long-term commitment, with most loan terms reaching 10, 15, or even 30 years. Many things can happen in that time – your life could take unexpected turns, your financial situation could change, the market could fluctuate, and suddenly your mortgage payments, like credit cards, can become unaffordable. This is a situation many homeowners find themselves in, and at that point, opinions may vary, but it may be a good idea to consider a mortgage refinance.

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‍Fortunately, borrowers can change their loan terms by refinancing, akin to doing a refi on your student loans. This business of trading one loan for another might be a practical solution under certain circumstances. Not sure if this is the right step for you? Keep reading to gather more content, turn the page on your financial journey, and learn when to refinance a mortgage.‍

How to Refinance

How does refinancing a mortgage work? Refinancing a mortgage is a process that allows a homeowner to replace their existing mortgage loan with a new loan with different terms. Refinancing shares many of the same features of home purchasing, minus the worry and pressure of needing to move and close by a set date. This process can help reduce monthly payments, lower the interest rate, or even switch from an adjustable to a fixed-rate mortgage. 

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Refinancing can be a great way to save money in the long run, as it can help you reduce the interest you pay over the life of the loan. When mortgage interest rates decline, and many homeowners are looking to refinance, lenders become inundated, and the refinancing process can be drawn out. If you become dissatisfied, you can usually call off the transaction by the third business day after completion.

Steps to Refinancing a Mortgage

1. Calculate the finances of refinancing to determine whether it makes economic sense
2. Obtain loan estimates from several lenders and choose a new mortgage type
3. Apply to the lender of your choice and submit the necessary financial records
4. Lock in the interest rate for the new refinanced loan to ensure the best rate
5. Attend closing day to sign the paperwork and pay closing costs  

Benefits of Refinancing

• Lowering Interest Rates: One of the primary reasons homeowners choose to refinance is to secure a lower interest rate on their mortgage. Suppose interest rates have dropped since you initially obtained your mortgage or have improved your credit score. In that case, refinancing allows you to replace your existing loan with a new one at a more favorable interest rate. A lower interest rate can result in significant long-term savings by reducing your monthly mortgage payments and the overall cost of borrowing.
• Reducing Monthly Payments: Refinancing can help homeowners reduce their monthly mortgage payments. Extending the loan's repayment term can spread out the remaining balance over a more extended period. That can result in lower monthly payments, making it easier to manage your finances or free up cash for other purposes. However, it's essential to consider the total interest paid over the extended term, as it may increase despite the lower monthly payments.
• Debt Consolidation: Homeowners may refinance their mortgage to consolidate high-interest debts, such as credit card balances or personal loans. By refinancing, you can take advantage of lower interest rates offered on mortgages compared to other forms of debt. By consolidating your debts into a single mortgage payment, you can simplify your finances and potentially reduce your overall interest expenses.

Drawbacks of Refinancing

• Closing Costs and Fees: Refinancing typically involves closing costs and fees, similar to when you initially obtained your mortgage. These costs can include application, appraisal, title search, and attorney fees, among others. Depending on the loan amount and the lender, these costs can add up to several thousand dollars. It's important to factor in these expenses when evaluating the financial benefits of refinancing. If the closing costs outweigh the potential savings, better options may exist than refinancing.
• Extending the Loan Term: While extending the loan term can lower your monthly payments, it also means you'll make mortgage payments for a more extended period. For example, if you've been paying off your current mortgage for 15 years and choose to refinance into a new 30-year mortgage, you'll restart the clock on your repayment period. As a result, you may end up paying more in interest over the life of the loan, even if you secure a lower interest rate. It's important to consider the long-term cost implications before deciding to refinance.
• Potential Prepayment Penalties: Some mortgages include prepayment penalties, fees charged if you pay off your loan early or refinance within a specific timeframe. These penalties can vary depending on the terms of your mortgage agreement. Before refinancing, you must review your existing loan documents and consult your lender to determine if any prepayment penalties apply. If the penalties are significant, they could offset the potential savings of refinancing, making it less financially advantageous.

When To Refinance Your Mortgage

Refinancing is when you take on a new loan to settle an existing loan. You could think of it like using a credit card to pay off another. Getting in debt to get out of debt may seem like a fool-hardy mistake from a numbers standpoint, but that’s not always the case. Here’s why:‍

You Want To Take Advantage Of Lower Interest Rates

One of the biggest reasons for refinancing is to get a lower interest rate than the one you’re currently paying. Paying less interest means you’ll save more money and build home equity faster, which helps in reaching your goals. Even a 1-2% interest rate reduction can save you thousands of dollars in the long run, reducing the closing costs of refinancing and the mortgage payment.

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To check the latest mortgage lending rates nationwide, look to the Consumer Financial Protection Bureau. This lender-friendly service can provide substantial and accurate content, aiding in making informed decisions.

You Want A Shorter Period of Payment

Another major factor in the affordability of your mortgage is how long you are paying for it. The most common mortgage periods are 15-year and 30-year mortgages, but loans of different time spans are available based on your unique needs, much like the variety of credit cards available.

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Refinancing to a shorter loan term can help you save on interest. Let’s take, for example, a $200,000 loan with a $40,000 down payment ($160,000 loan amount). Even with the same interest rate and principal, you’ll pay more than twice as much interest with the longer loan term. Therefore, it's clear that the loan-to-value ratio plays a significant role in the refinancing process, influencing the way you handle your money.‍

You Want To Switch Interest Loan Types

What kind of mortgage do you have? Is it an adjustable-rate mortgage (ARM) or a fixed-rate mortgage (FRM)? Depending on the circumstances, you might want to consider switching over to the other one. You could leverage the advantages of each loan type to your benefit, just as you would while choosing between different credit cards.

When To Switch From A Fixed-Rate Mortgage To An Adjustable-Rate Mortgage

The main reason people convert from a fixed-rate mortgage to an adjustable-rate mortgage is to take advantage of the initial lower payments, especially when interest rates are high, just like considering a refi of student loans or how one would use cash-out refinancing. Here are other reasons why:

You Think That Interest Rates Will Get Lower

With an FRM, you pay the same amount every month, but doing so when the interest rates decrease means that you’ll be paying more than necessary for your mortgage payment. In this case, it makes sense to switch to an ARM when interest rates are lower, as your mortgage will also become more affordable.

You Plan To Sell Your Home Soon

ARMs have low fixed interest rates for the first few years of the loan. After this point, your rates can be adjusted yearly to reflect the current market.‍ ‍If you have an FRM but plan to sell your house in the next few years, it could be worth refinancing to an ARM. You’ll be paying a lower mortgage rate in the meantime, and you can avoid the possible rate inflation by selling the property before the initial low-interest period is over. 

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That could be particularly beneficial for those whose goals include selling their property. Thus, by wielding the power of mortgage lenders and employing ways such as implementing a home loan, you can protect your borrower's interest while carrying out a smart business move and offering them suitable compensation.

You Are Expecting An Increase In Cash Flow

If you cannot afford your current mortgage, refinancing to an ARM can help you save on interest while you build your finances. Refinancing with an FHA-approved lender, for instance, offers some benefits. Such a step could offer a lifeline for you in a financially straitened situation.

When To Switch From An Adjustable-Rate Mortgage To A Fixed-Rate Mortgage

People usually refinance their ARM to an FRM if the current mortgage rates are lower than they currently pay. A site with a robust mortgage calculator can be a reliable tool to streamline this research. Here are other times when it’s wise to convert from ARM to an FRM:

Your Low Fixed-Rate Period With An ARM Is Coming To An End

Based on various factors, mortgage payments under the ARM scheme usually fluctuate after a set period. In some cases, they may even exceed standard FRM rates. In this case, converting to an FRM with a lower interest rate would make sense.

You Want Your Expenses To Be Predictable

While there are limits for the adjustments (e.g., margins, rate caps) in an ARM, you might want to convert to an FRM if you value stability or predictability.

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With an FRM, you never have to worry about a possible drastic increase in mortgage prices. That is incredibly comforting if you’re settling down in your forever home. The unchanging mortgage can ease your mind and make planning for your expenses more manageable.

When Not To Refinance Your Mortgage

Are you already considering refinancing your mortgage? First, take a step back and look at the whole situation from a broader standpoint. Aside from looking at the market conditions, you should also consider your personal financial circumstances and other factors to determine if refinancing now is right for you.

Your Credit Score Has Decreased

If your credit score has decreased since you’ve taken your original mortgage, it might be better to hold off on refinancing your mortgage until you can build it back up. Lower credit scores make it more challenging to get your refinancing plans approved. Moreover, a hard inquiry will be run on your credit report when you apply for refinancing, deducting points from your score.

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However, if your credit score has increased, you may qualify for a better interest rate – it might be worth making inquiries with mortgage lenders.

You Cannot Afford Refinancing Costs

Refinancing may seem like a simple transaction of taking a loan to pay an existing loan, but it’s not free or cheap! Aside from the closing costs (usually 2-5% of the principal loan’s total value), you must also consider appraisal fees (usually $300 to $600), origination fees (1% of the principal loan’s value), title search costs, and credit check fees. Moreover, check if your current mortgage offers prepayment penalty fees if you pay off your loan before a specific period.

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Refinancing your mortgage is only a sound financial decision when the total refinancing costs are lower than the savings you will get.

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Conclusion

Being a homeowner is a goal for many people to achieve through a mortgage. However, with ever-changing circumstances (i.e., higher or lower interest rates, selling or keeping your home), it is wise to keep an eye open for refinancing opportunities. You might be able to lower your total mortgage payments through a more favorable interest rate or a shorter loan period.

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Refinancing is not always easy, but you can contact us here at Wesley Mortgage for help. As an experienced lender, we understand that each potential borrower has a unique set of needs, and we're here to provide all the reliable information required to guide you down the best financial path for you!