Refinancing your mortgage is something most homeowners consider few times throughout homeownership. It allows you to pay off your previous mortgage by applying for a new one that has better financial advantages, or even take out equity at a lower interest rate than a 2nd mortgage. These are known as rate-and-term refinances and cash-out refinances, respectively.
A rate-and-term refinance only makes sense when your interest rate is a lot higher than the current best mortgage rates available. While you can save thousands of dollars by going from 3.39% to 2.64%, you would also have to pay mortgage penalties. Unless the amount of money you save by switching to a better rate is more than what you’d have to pay in penalties, it isn’t worth it to switch.
However, a cash-out refinance is much easier to justify. If you need cash quickly and cheaply, a cash-out refinance lets you access your home equity and often at lower rates than a complete second mortgage or personal loan.
While there are many good reasons to refinance, here are four common ones.
One of the biggest reasons homeowners look to get a refinance is because they saw that interest rates have gone down from when they bought, and they’re hoping to cut their monthly payments.
However, as said earlier, it’s not always the best move to refinance just to get a lower rate. Fixed mortgage rates have high penalties for breaking early. Variable mortgages are 3 months’ interest only, which make them easier to break, but variable mortgages go down when interest rates do – often negating the need to break the mortgage in the first place.
One of the worst parts about having a low credit score is interest rates on mortgages are a lot higher than the interest rates you would get if you had excellent credit. You may have only qualified for a private mortgage at a rate of 7%, but your credit has improved to the point where you can qualify for the best mortgage rates in Canada.
While the jump from 3.39% to 2.64% might not be large enough to justify breaking your mortgage, the jump from 7% to 2.64% definitely would be.
If you’re concerned that rates are going up and want to lock in your lower adjustable rate mortgage, you might consider locking in your rate before rates go up. This has the potential to save you a lot of money by the end of your term, but only if rates go up.
This isn’t a decision that you should make without consulting an expert in the mortgage industry. While anyone that claims to know exactly what will happen to rates is a liar, they can provide sound reasoning as to why they believe rates will go up or down, as well as the likelihood of you saving money.
This is the best reason to get a refinance in most cases. Interest rates have to be very different before it makes financial sense to refinance just for the rate, but taking out your equity to use elsewhere is always useful.
If you use the money you take out of your equity for debt consolidation, home improvement, or investing, you stand to earn more money by using your home equity and paying the interest than you would save by not refinancing.
But be careful by taking out too much of your equity! You don’t want to use your equity as an ATM to fund your lifestyle, because that leaves you in a dangerous position if house prices ever fall. You could end up owing more than your home is worth, which makes it impossible to sell your home without paying off the difference.
It’s easy to recommend a cash-out refinance to anyone that has home equity and needs a loan, as the interest rate for refinancing is a lot lower than most other loan types. Unless you plan on using it on something that doesn’t improve your financial situation, such as a vacation or luxury car purchase, then getting a refinance is a good idea.
But getting a rate-and-term refinance isn’t as easy to recommend. Unless the savings of the lower interest rate outweighs the mortgage penalty you’d pay for breaking your mortgage, it can actually be a better idea to stick with your current, higher interest rate.
It can seem counter-intuitive for the best option to be “keep paying more,” but trying to save $3,000 by spending $3,500 doesn’t make any sense either.
Be sure to talk to a mortgage broker who can figure out what your savings would be and how large a penalty you’d have to pay before refinancing.