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Refinancing a mortgage can be one of the most effective tactics to improve your financial outlook, as a homeowner. Homeowners might refinance to cut their monthly payments or build equity faster. Sometimes they do it to take advantage of boosted credit scores. It can be a versatile tool. 

That said, refinancing isn’t for everyone, and there’s a lot that should be considered going into it. You’ll need to think about timing, interest rates, personal goals, income, and more. In this guide, we’re going to dig into what refinancing really entails and when it’s best used. Armed with the right strategy, you’ll be better-equipped to make a decision that will save you money and improve your long-term stability. 

What Mortgage Refinancing Means

We’ve mentioned “refinancing” a few times, but what does it really mean? Well, it’s not terribly complicated. Refinancing is taking out a new loan, with better terms, specifically to pay off and replace your existing mortgage. 

In most cases, you’re refinancing to get lower interest rates, at least. Though sometimes homeowners will refinance to shorten the repayment period, or to change the entire loan type or interest structure. Some refinance to access equity so they can renovate or consolidate debt.

Refinancing can also reduce the total amount of interest you pay over time. This is particularly valuable if rates have dropped substantially since you took out your original loan. Though, as we’ll talk about a little more later on, refinancing isn’t always about chasing the lowest rate. Sometimes the best advantage is simply finding a loan structure that fits your current financial priorities better. 

Knowing When Refinancing Makes Sense

Refinancing can be a great option in a wide range of situations, but most notably, when it helps you reach a specific, measurable goal.

The most common reason is to lock in a lower interest rate. Lowering your interest rate cuts your monthly payments, and a change of just half a point can save you thousands over the years.

Another reason is to switch your loan structure from fixed-rate to adjustable-rate (ARM), or vice versa. Homeowners with ARMs generally move to fixed-rate loans for increased payment stability or to shorten their loan term. Homeowners planning to sell soon may refinance into an ARM to drop their interest rate to free up cash for renovations.

Regular, undramatic life changes can also be the impetus to refinance. Reaching a higher credit score threshold, getting a promotion with more income, or eliminating debt are all very likely to qualify you for better loan terms. Sometimes, refinancing can allow you to cash out equity in your home, putting money in your pocket while getting you better loan terms. 

How to Calculate Your Break-Even Point

Before making any decisions, it’s critical that you know your personal break-even point. Your break-even point is the time it takes for the monthly savings from your new mortgage to equal the costs of refinancing. These costs will typically include appraisal fees, application fees, loan origination fees, and closing costs. You can also include potential tax impacts or added benefits, such as removing mortgage insurance or shortening your loan term.

Let’s look at a simple example. If you save $200 per month after refinancing, but it costs you $4k to do it, then your break-even point is 20 months. So, if you’ll be living in the home longer than that, refinancing makes sense. If you plan to move in 18 months, it’s a losing proposition.

Common Mistakes to Avoid When Refinancing

Refinancing your mortgage can save you money and improve your financial health. But, only if you steer clear of the pitfalls that typically catch homeowners off guard. Check out this list of the most common mistakes, and how you can actively prevent them.

  1. Focusing only on the interest rate: Many borrowers look solely at the new rate and overlook the full loan cost. A lower rate can still lead to higher total interest if you extend your loan term. Always compare total repayment amounts rather than just the monthly savings.
  2. Ignoring closing costs and fees: Refinancing comes with expenses like application fees, appraisals, and title insurance. Failing to factor these in can delay your break-even point or wipe out expected savings altogether.
  3. Not comparing multiple lender offers: Rates and fees vary between lenders. Getting at least three quotes can help you find the best combination of rate and closing cost.
  4. Refinancing too often, or too soon: Frequent refinancing resets your loan term, which can slow equity growth. Waiting until your credit improves or rates drop more significantly ensures the move is worthwhile.
  5. Taking cash-out funds with no plan for them: Using home equity for unnecessary spending can lead to more debt. If you take cash out, make sure it’s for productive goals like home upgrades or paying off higher-interest loans.

Knowing When to Wait

Now you know when to refinance, but when shouldn’t you? Don’t refinance if:

  • You plan to sell your home before what would be your break-even point
  • Your existing interest rate is already competitive
  • Market rates are climbing or expected to stay flat
  • Your credit score has gone down
  • Your debt has gone up
  • You’ve recently made any other large purchases, like a vehicle

On top of that, if you or your finances are in transition, like during a job change, results can be inconsistent, depending on what’s been reported to the bureaus. Waiting until your income and credit are steady can help ensure the terms you’re offered are the ones that fit your finances. 

Make Refinancing Work for You

Refinancing can boost your cash flow and reduce interest costs, but it can also be a great general strategy to help you reach new financial goals. The key is that you have to approach it with a plan, along with realistic timing. But, most of all, you need to have a clear grasp of the costs that are involved. 

When used strategically, refinancing can put your money to better use while strengthening your long-term financial health. For Expert local advice and competitive lending options, reach out to our lending team and tell us about your needs.