When interest rates are falling, people think about refinancing their home loan for many reasons. Let's talk about six of them:
1. Refinance to save money on interest payments
Many people refinance to reduce their mortgage interest rate and save money on interest payments when rates are falling. Financial professionals often recommend people consider refinancing when current rates are substantially lower than the rate on their current mortgage. That's because refinancing often requires you to pay a new set of closing costs, and the money you save on interest needs to be enough to make paying these new closing costs worthwhile.
To save more money, continue to pay the same amount on your mortgage every month. This way you'll be using the money you save on interest to pay down the principal balance faster.
2. Refinance to lower your monthly payments
When you refinance your home loan, you don't have to use the money you save to pay off your mortgage balance sooner. You can take the monthly payment savings and pay other bills, save for college, or invest in your retirement fund.
3. Refinance to get cash from your home equity
Another reason people refinance is to get cash from their home's equity. This is called a "cash out" refinance. You replace your existing mortgage with a new loan for a higher amount, and you get the difference in cash at closing. People use the money from a cash out refinance to do things like pay off high interest debt, pay for home improvements, or pay for college education. You typically have to complete a new mortgage application and pay a new set of closing costs when you want a cash out refinance.
4. Refinance to shorten the life of your home loan
Another way to save money is to pay off your loan sooner. Some people who have 25 years left on their home loan think about refinancing to a 15 year mortgage. These people might save money because they are paying off their loan sooner, which means they are paying less interest over the life of the loan.
Keep in mind that shortening the life of your home loan might increase the amount you are required to pay each month. Also remember that refinancing is not usually necessary to paying off your home loan sooner. Many people just make extra mortgage payments to save money on interest. Before you make extra payments, check your loan terms to make sure you don't have a pre-payment penalty.
5. Refinance to make your monthly payments more predictable
People who have an adjustable rate mortgage sometimes refinance to a fixed rate mortgage because they want the peace of mind of knowing that their monthly interest payments won't change. Find out more about refinancing to a fixed-rate mortgage.
6. Refinance to stop paying mortgage insurance
Finally, refinancing can help people stop paying mortgage insurance. With a conventional loan, you can usually stop paying private mortgage insurance (or "PMI") without refinancing. Most borrowers can stop paying PMI when their home's equity reaches 20%.
With an FHA loan, the rules are different. Borrowers who have gotten FHA loans in the recent past have to pay mortgage insurance premiums (or "MIP") for at least 11 years. And depending on how much money these borrowers paid as a down payment, they may have to pay MIP for the life of the loan. In these cases, borrowers sometimes refinance their FHA loans to conventional loans to stop paying mortgage insurance premiums.
How much money might you save refinancing your home loan?
For an estimate of how much you might save with a refinance, check out our calculator.