Given the current economic climate, we all find ourselves trying to save money where we can. For homeowners, refinancing your mortgage loan is a useful solution in times of financial strain. But how do you get started, and what are the risks?

This short guide will explain the different types of refinancing options, when you should refinance, and the associated benefits. Make an informed decision today that could lower your monthly payments and save you money down the line.

Mortgages and Interest Rates 

The rate of interest charged on a mortgage is better known as mortgage rates. In most cases, the rate of interest on a mortgage gets determined by the lender. The interest rate is fixed, meaning it stays the same, or variable where the rate fluctuates for the duration of your mortgage.

Furthermore, variable or adjustable rates are initially fixed. Soon after, they can go up or down based on the market.

Factors that Determine Your Mortgage Rate

The cost of interest that you pay on your mortgage gets determined by various factors. These factors, when weighed together, will determine how high or low the interest is that you have to pay on your mortgage.

• Down payment
• Loan type 
• Loan term
• Credit score
• Home price and loan amount
• Interest rate type
• Home location

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What Does it Mean to Refinance a Mortgage?

In a nutshell, refinancing your mortgage means that the lender will pay off your previous mortgage in exchange for a new mortgage agreement. The two primary forms of refinancing are term and cash-out. 

Term Refinancing

In a term refinancing, you’d likely get a smaller interest rate with your new mortgage, along with a shorter term of repayment. So that could be a 30-year term getting reduced to 15 years. 

However, be advised that the lower interest rate amount may result in similar monthly payments in the shorter term. 

Another term to be aware of is your “break-even point”. That is the point at which you have recouped the costs of financing as a result of a shorter repayment term or lower monthly payments. 

Cash-Out Refinancing

This option allows you to refinance up to 80% of the current home value in exchange for money. Say your home is worth $100,000, and you still have to pay $60,000 to the lender. The lender can offer you $20,000 as a cash-out, which would reduce your new mortgage to $80,000. 

It’s important to note that you aren’t always saving cash when you refinance with this option. You are instead getting a lower interest rate, in a sense, while also receiving much-needed funds. Simultaneously, there is a chance of a longer repayment term and/or larger monthly payments. 

This money is not free and must get repaid. People choose this option when they want to renovate their home, take a vacation, or if they need help financially. 

When and Why Should You Refinance Your Mortgage? 

Refinancing your mortgage has many benefits, though they vary from person to person, depending on their individual goals. In general, these are the benefits of refinancing a mortgage loan:

Lower monthly payments: For example, if you have a 30-year fixed-rate mortgage, and an interest rate of 5.5% with a home value of $100,000, the principal and interest payment equates to $568. This same loan with an interest rate of 4.1% will reduce your monthly payment to $477.

Better mortgage rate: This is the primary reason for refinancing if you see the market is changing and rates are lower than they were when you borrowed for your loan. Or, maybe you have a better credit score, and you’ve become eligible for lower rates. 

Remove someone: Refinancing is the only way to remove someone’s name from a mortgage in cases of divorce or if someone wants to be freed from liability if they were a co-signer.

Predictable payments: You can choose to switch to a fixed-rate loan (from an adjustable-rate) so that you can lock in the cost of your monthly payments for the duration of your loan term.

Borrow cash: With the cash-out option, you can get funds for any reason by borrowing against the equity on your home. The amount you receive gets added to the principal that you owe. 

Shorten your loan term: Borrowers often switch from 30-year to 15-year loans so that they can pay their mortgage off faster and save money on interest. The payments on 15-year loans are usually much lower as well. 

Combine mortgages: You have the option to add a second mortgage into your primary mortgage for one single payment. This option is similar to a cash-out refinancing, but you’re using the funds to pay off the other mortgage, so it doesn’t reduce your home equity. 

Consolidate your debts: You can choose the cash-out option to pay off significant debt and save money over time on interest with reduced payments. 

Cancel your mortgage insurance: If your lender pays your mortgage insurance, you’ll be able to refinance when you reach 20% equity. This cancels out the built-in premium that you pay on your interest rate. 

Final Thoughts

It’s good to understand the importance of mortgages and interest rates, as well as which factors will affect your initial interest rate when you purchase a home. Try this mortgage calculator to determine what your monthly payments would be based on your current situation.

Refinancing your mortgage is a great choice for many people. Remember that before you go down the road of refinancing your loan be sure that this decision makes sense for you financially.

Use these tips that we’ve provided here and get on your way to saving money by refinancing your mortgage!

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