Considering how much it costs to buy a house, it only makes sense why mortgages are the only sustainable way to make becoming a homeowner an actual possibility for people. It is a huge investment to take out a mortgage and buy a house. But the best thing is, there are other services you can get access to once you have an active mortgage, especially if it has been active for some time because you have continued to make regular payments towards your loan.

One of these services is the option to refinance your mortgage. But considering how much work and investment it took to get the first mortgage, is refinancing your mortgage a good idea? To help address when refinancing is a smart choice, here is a guide that addresses this question.

Why Should I Refinance My Mortgage?

Refinancing a mortgage can have a lot of benefits but whether this is beneficial depends on your exact circumstances. While some argue that refinancing is beneficial just because of the benefits, this is not entirely true because different people have different circumstances and what works is strongly dependent on your goals and financial position.

The first thing to remember what a refinance is. A mortgage refinance involves the process of replacing the original mortgage with a new one, so not only is this a good idea for everyone with a mortgage, but it might also not be beneficial for all.

>>More: When Should you Consider Refinancing your Current Home Mortgage?

Having said that, let’s look at when refinancing your mortgage could be useful.

1. You need to change your loan term

There are two reasons you will want to change the term of your mortgage:

– You want to increase the loan term
– You want to decrease the loan term

Why increase the loan term?

If you originally signed up for a mortgage with a short term, for example, a loan with a term of 15 years, then you can refinance your mortgage to increase the term to 30 years. Short-term mortgages are great if you want to pay off the loan early but that also means your monthly payments will be high. There can be multiple reasons why your monthly payments might become a burden, it could be that your financial circumstances have changed or there was some emergency where you had to use a lot of your savings. Unfortunately, there are circumstances that cannot be controlled but thanks to refinancing, you can at least control how much you pay every month.

By refinancing into a mortgage with a longer-term, you can lower your monthly payments and get some relief from the payments before. This can provide savings in the shorter term. But it is also important to keep in mind that by increasing your term, the interest rate will increase. While your monthly payments will decrease, your total loan amount will increase. So increasing your loan term is good if you are looking to lower your payments in the short term while increasing the overall loan amount.

Why decrease the loan term?

The situation with changing your loan term to a shorter one is the opposite of what happens when you increase the loan term. If you have a loan term of 30 years, you can refinance it into a term of 15 years. As a result, you will end up with a lower interest rate, your loan will be paid off earlier than planned but your monthly payments will increase.

At first glance, it may seem strange that someone will want to pay more towards their mortgage but it can be beneficial. Some loans have a penalty for paying the loan off early, in such a case it is not possible to simply keep the loan as is and just make larger payments. But if the borrower refinances their long mortgage into a shorter one, they will be free from such a condition and will be able to pay off their loan faster. Paying off the mortgage faster is a great option if your income has increased or you gained additional sources of revenue. A shorter mortgage means you will be free from debt faster, your credit will look better and you gain equity in your property at a faster rate, for these reasons refinancing your mortgage term into a shorter one is a very smart move.

2. You need urgent cash

If you have been paying for your mortgage diligently for a few years, then you have been slowly gaining more and more share of the house. When you take out a mortgage, the house itself is the collateral and since it was paid for by the lender, they own most of the share in the property. As you continue to make repayments towards the loan, you also continue to gain more ownership of the home, this ownership is your Equity. Your equity in the property is a great asset you can utilize to leverage more benefits. One of them is a Cash-Out Refinance.

A cash-out refinance, allows you to refinance your mortgage to obtain a lump sum cash amount. There are other ways to use this form of refinancing but this is the most popular one. Cash-out refinance is mainly used when you have an urgent requirement of a large cash amount, mainly this is for medical emergencies but people also use this option when repairing or renovating their properties. There is no restriction on what you can do with the amount once you refinance but it is important to only use it for emergencies because you are using your equity to refinance.

3. You want to convert an ARM to a fixed-rate mortgage

Mortgages are available with two kinds of interest rates and it is possible to refinance from one type to another:

Refinance to Fixed Rate Mortgage

Fixed-rate interest has the benefit of being predictable and constant. The most important thing about these interest rates is that they are dependent on the contract rather than the market. If for example the interest rate of the contract is 3% and the rate in the market has increased to 3.9%, because this is a fixed rate mortgage, the interest rate will remain at 3%. This is great if you have a long-term mortgage and you don’t want to move from your property any time soon.

However, the consistency of a fixed rate mortgage is also a concern. If the interest rate in the market drops to 2.8%, you will not have access to this lower interest rate.

Refinance to Adjustable Rate Mortgage

Adjustable interest rates, as their name implies, are flexible. Unlike fixed-interest rates, adjustable rates are contractually linked to the market. If the interest rate in the market changes, so do these rates. In an adjustable-rate mortgage, the rate is fixed for the initial period of the loan and then after this point, the rate becomes an adjustable-rate. Meaning, these interest rates are very helpful if you are planning to hold on to the property for some years and then sell it. Because in the initial years you will have access to the fixed rate, which is usually low, and once you sell, you don’t have to worry about the market rates. However, even if you do plan to stay in the property long term, the lower rates in the initial period can help you save money, and later on you could finance to a relatively higher but fixed rate.

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