Refinancing Your Housing Loan – When Should You?
If you’ve looked into the interest rates for loans lately, you might have noticed that they are way lower than usual. You may be tempted to refinance your housing loan and replace your current loan which is too expensive. Although the lower rates are attractive – it’s not the only factor to consider when refinancing.
Deciding whether to refinance your housing loan is just as important as deciding to purchase a new home. Refinancing involves the act of replacing existing loans with a newer loan that pays off the debt of the old loans. Hence, it’s critically important to evaluate the situation properly before proceeding to refinance.
As such, this article aims to provide you facts about the advantages and disadvantages of refinancing so you won’t take unnecessary risks.
- Reduce Your Monthly Commitments
- Pay Off Your House Faster
- Reduce Your Loan’s Interest Rate
- Cash Out for Personal Funding (perhaps for your next IKEA renovation)
- Consolidate Debts for Easier Payments
- Might Increase Monthly Payments
- Restarts Your Mortgage Term
- Might Not Be Beneficial If You Plan to Move Out Soon
- A Good Credit Score is Required for Lower Interest Rates
- Might Lead to Overspending Which Risks Your Personal Finance (or worse, your home)
Advantages of Refinancing
Why should you refinance your mortgage? Consider the following and evaluate whether it applies for your situation.
Reduce Your Monthly Commitments
When you refinance your loans for a lower interest rate, your monthly payments will be reduced consequently. Why so? You are paying less in interests monthly which means you’re also paying less over the term of your loan.
It typically applies to cases where you keep a 30-year mortgage term for the loan and better terms relieve you of financial stress in the long run.
Pay Off Your House Faster
In certain cases, you may want to refinance your loan into a shorter term, such as from a 30-year loan to a 15-year loan. This allows you to pay off your house sooner and own the house entirely which saves you a significant portion of the money that would have gone to interest payments.
Reduce Your Housing Loan’s Interest Rate
This is self-explanatory, you might’ve found a better loan offer with lower interest rates down the line while owning a house and refinancing allows you to switch to that loan to reduce your interest payments.
Not only that, if your existing mortgage is an adjustable-rate mortgage (ARM), refinancing your mortgage into a fixed-rate loan can lock in the interest rate and monthly commitments, subsequently making it easier for you to plan your finances.
Cash Out For Personal Funding
Depending on the market value of your house, refinancing your mortgage might end up providing you with extra cash for various purposes. The extra cash can be used to pay off your personal debts, fund your education, start a new business, and even fund home improvement projects that increase market value.
Consolidate Debts for Easier Payments
If permitted by your creditors, you can combine multiple loans into one through refinancing. As such, your monthly payments can be paid off through one account with one interest rate instead of through multiple accounts with variable interest rates – thus, simplifying your finances. To understand better about debt consolidation, read our article on the topic!
Disadvantages of Refinancing
Sometimes refinancing is just not the wise option for you and in the following scenarios, it may not be suitable for you to refinance your mortgage.
Increasing Monthly Payments
If you choose to shorten your mortgage from a 30-year loan to a 15-year loan, it can cause your monthly commitments to be significantly higher as you have a shorter timeframe to pay off your mortgage. Your cash flow can be impacted and strained by this decision causing you to live with a tighter budget.
Restarts Your Mortgage Term
If you refinance your home into a 30-year mortgage and your existing mortgage was already paid for 4 years, your mortgage term is restarted and you will be expected to pay off your house much later in life.
The longer you’ve paid off your existing loan, the less likely it is that refinancing your mortgage is a good choice unless you are planning to refinance into a shorter-term mortgage.
Might Not Be Beneficial If You Plan To Move Out Soon
With closing costs capped at around 3% to 6% of your mortgage, refinancing wouldn’t make sense if you plan to move soon.
On top of that, there are also various upfront payments to be made after your refinancing application such as legal fees, appraisal fees, loan origination fees, and much, much more. Thus, you shouldn’t be considering moving if your interest savings have not outweighed your upfront payments, refinancing is not an option in these circumstances.
A Good Credit Score Is Required For Lower Interest Rates
When searching for a refinancing option, you’ll notice that all creditors have their own requirements for refinancing, but to get the best interest rates for refinancing, you need to have a good credit score.
According to CTOS, only credit scores of 697 and above are considered to be good, very good, or excellent. If your credit score is lower than 697, you might be offered higher interest rates, which might not be better than what you already have.
Might Lead to Overspending Which Risks Your Personal Finance
Being able to cash-out refinance is definitely a great thing that can help you solve some financial troubles. However, it is not a good idea to use it to pay off your unsecured debts (especially credit card debts) and make unnecessary large ticket purchases.
Missing payments on your credit card may impact your credit score, but missing payments on your mortgage may lead to you losing your house! The situation worsens if your housing market value declines and increases your debts.
To Wrap Things Up
Essentially, refinancing your housing loan depends heavily on your financial situation and ultimately your financial goals.
Make sure to carefully consider your situation and evaluate the pros and cons of refinancing to make the right call.
If you still find yourself having difficulties in making the right decision for refinancing, IBPO’s i-Refinancing service can help you through the process.