Refinancing the mortgage on a home is most simply defined as a process that pays off the existing mortgage on a property while establishing a new mortgage in its place. This is typically done to get the home buyer a reduced interest rate, but people have their mortgages refinanced for a host of other reasons.
Reasons to Refinance
A number of life circumstances can prompt a homeowner to refinance their mortgage.
To Cover Large Expenses
One of the most common reasons for refinancing is to help a person or family pay for large expenses. Higher education, medical expenses and expensive emergencies can be paid for with the money granted by the refinancing of one’s mortgage.
If this is the case when a homeowner seeks to refinance, they should make a pointed effort to formulate a long-term repayment plan. This kind of refinancing is best utilized when the money is being put toward an investment toward the family or individual’s future. An investment has to be worth it and a repayment plan put in place, particularly since the home can be used as collateral in the event that the loans are not repaid.
To Get a Lower Interest Rate
If a person’s credit score has dramatically improved since the beginning of their mortgage term, they could actually save money by breaking their existing contract in favor of a mortgage with a lower interest rate. A better credit rating equates a lower interest rate on a mortgage, and being in the middle of a mortgage shouldn’t necessarily be enough to stop everyone from saving money this way.
There are typically fees associated with refinancing, and they are not cheap. But what a homeowner saves in interest could end up saving them money in the long run, even with these fees added.
To Lengthen the Mortgage Term
If a homeowner finds themselves struggling to stay on top of their mortgage payments, they may choose to refinance in order to lengthen the term of their mortgage. This enables them to pay smaller monthly repayments, which could make the difference between foreclosure and staying in their home.
To Shorten the Mortgage Term
Sometimes, a homeowner might want to get out of their existing mortgage earlier than the agreed-upon term initially indicated. Refinancing a 10-year mortgage term into a 5-year mortgage term means paying off the mortgage faster. Once the 5-year mortgage is paid off, the homeowner has the option to renew it with their existing lender or pursue different lenders.
Methods of Refinancing
There are two common methods that a homeowner can utilize to refinance the mortgage on their home.
Breaking their Existing Contract
Breaking a contract with an existing lender will carry with it penalties and fees, but the amount of money that the homeowner is saving by refinancing could make those fees worth the cost. This method eliminates the existing mortgage and allows the buyer to pursue a new mortgage with a new lender.
Accessing Home Equity
Home equity refers to how much of the mortgage has been paid off, or how much of the home the buyer actually “owns.” Homeowners are allowed to borrow money against the value of their home in either one large lump home equity sum or as a home equity line of credit (HELOC) that enables them to withdraw the money as they need it.
Using a home’s equity to pay for expenses involves repaying the money borrowed against the home, as well as continuing payments on the mortgage.
Refinancing a mortgage comes with some risks, particularly as the house can be put up as collateral in the event of going into default. But when it is done wisely and realistically, the homeowner could actually save themselves significant funds, pay off their mortgage faster, or avoid foreclosure.