Right now, thousands of Americans are preparing to refinance home mortgage loans. Hopefully, they have done the proper research to determine that mortgage refinancing is, in fact, a wise move for them to make. And hopefully, they can refinance their home mortgage loans in a way that saves them a lot of money over the life of the loan.
But why do people turn to mortgage refinancing in the first place? What are the top reasons for refinancing a home mortgage loan? Here are some of the most common reasons, as cited by the homeowners / borrowers themselves.
Reasons for Refinancing Home Mortgage Loans
1. To Lower the Monthly Payment
Many people use mortgage refinancing to obtain a lower interest rate on their loan, thereby reducing the size of their monthly mortgage payment as well. For example, if you buy a home when interest rates are unusually high, and those interest rates drop considerably a few years down the road, you could refinance the home mortgage loan to capitalize on the lower interest rates of the time.
You could also quality for a lower interest rate if you dramatically improve your credit score. This is another scenario where it might make sense to refinance the mortgage to obtain a lower rate / monthly payment.
But use caution. A lower interest rate will only save you money when spread over a certain period of time and a certain number of mortgage payments. You will pay closing costs when you refinance the home mortgage, so you want to make sure the money save exceeds the money you pay in closing costs. Learn more from our related article, Should I Refinance?
2. To Pay Off the Loan Faster
Mortgage refinance is one of several ways to shorten the length of a mortgage loan (and thus pay off the loan faster). Perhaps the most common example is refinancing a home mortgage loan to go from a 30-year loan to a 15-year loan. Obviously, this could increase the size of the monthly mortgage payment, since it condenses the payments into a shorter period. But for homeowners who can afford the difference in monthly payment, and who want to pay off the loan faster, this can be a viable option.
3. To Get Cash Out of the Equity
Let's start with a basic definition of home equity, just so we're on the same page. Home equity is the difference between the home's value and the amount the homeowner still owes on the mortgage. If a home is valued at $100,000 and the mortgage balance is $90,000, the equity is $10,000 (or 10% of the home's value).
Many homeowners refinance home mortgage loans in order to draw cash out of their equity. This is called a cash-out refinance. With this option, the homeowner receives additional funds from the lender (in addition to the existing loan being paid off / refinanced). People use cash-out refinancing to pay for vacations, children's college tuition, home improvement, and other "big ticket" items.
4. To Avoid a Mortgage Adjustment
Many homeowners choose an adjustable rate mortgage as a way to obtain lower interest rates -- and thus pay a lower mortgage payment. But as the name implies, the adjustable rate mortgage will eventually adjust or "reset" to a higher interest rate.
When and how often the mortgage loan adjusts is something you will know in advance, because the mortgage lender is required by law to tell you such things. But you won't know the amount of the adjustment, because nobody can predict what interest rates will do in the future. This is the primary disadvantage of an adjustable rate mortgage, and it leads many people to refinance their mortgages prior to the adjustment phase.
When NOT to Refinance a Home Mortgage Loan
Here's the important thing to take away from this article. People use mortgage refinancing for many different reasons, and in many cases it's a smart financial move. But it's not the right thing to do in all occasions, as the cost of refinancing can sometimes exceed the savings. To learn about scenarios when refinancing is not the best move, read our article on when not to refinance.
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