6 Key Benefits of Refinancing Your Home Loan
Published on: January 3, 2025
What is the one thing most homeowners do when the interest rates dip? Yes, you guessed it right—they go for refinancing. Refinancing your home loan not only lowers the interest rate and shortens monthly installments, but it is beneficial in many other ways. The following are the top benefits of refinancing your home loan, but let’s start with the basics of refinancing.
What is Refinancing?
Refinancing, or “refi,” is the process of changing the terms or conditions of your current mortgage or loan. This often happens when a borrower seeks better conditions, such as a lower interest rate or a different payment schedule. If the refinancing request is approved, the old loan is replaced with a new one.
How Does Refinancing Work?
People usually refinance to save money, especially when interest rates change. For example, if interest rates drop, borrowers can refinance to lower their payments. Common reasons for refinancing include lowering interest rates, changing the loan’s duration, or switching between fixed and adjustable-rate mortgages.
Some borrowers also refinance because their credit score has improved or they want to change their financial plans. Others might consolidate several loans into one to reduce their overall debt.
The most common reason for refinancing is changes in interest rates, which are influenced by national policies and economic conditions. When rates drop, borrowers with variable-rate loans benefit by paying less interest. On the other hand, when rates rise, those with variable loans may face higher payments.
The process usually goes like this; a borrower contacts their current lender or a new one and applies for a new loan. The lender then reviews the borrower’s financial situation to decide whether to approve the request or not.
What are the Benefits of Refinancing Your Home Loan?
1. Lowered Interest Rates—Less Interest Payment
As mentioned above, one of the main reasons people refinance is to reduce their interest rate. A lower rate means there will be lower monthly payments, which can save you money each month. You can use these savings for other expenses, or you can continue paying the same amount you did before. This would help you pay off the loan faster and reduce the total interest you pay.
Example
Imagine you take out a 30-year mortgage for $200,000 at a 4% interest rate. After two years of payments, you would have paid $15,728 in interest. If you continue paying for the full 30 years, the total interest would be $143,739.
Now, you decide to refinance after two years into a new 30-year mortgage at a 3.5% interest rate. After making 24 payments, your loan balance is now $192,812. With the new loan, the total interest paid over 30 years would be $118,880.
However, we need to account for the $15,728 in interest you already paid during the first two years. Adding this to the new interest amount, the total interest you would pay is $134,608 over the life of the loan. This means, you will save more than $9,000 in total interest payments.
2. More Predictable Payments
If you have an adjustable-rate mortgage (ARM), your interest rate can change over time based on the market. This means your payments can go up or down each month.
Refinancing to a fixed-rate mortgage may make payments more predictable. The interest rate remains the same for the entire loan period, and your monthly payment stays the same. This stability can help you better plan your budget.
3. Reduced Monthly Payments
Refinancing can lower your monthly payment, especially if you extend the length of your loan. For example, if you keep the same loan term, your monthly payment will be lower because you have more time to repay the loan. If your interest rate drops, your payments will decrease even more.
Example
Imagine you have a $200,000, 30-year mortgage at a 4% interest rate. Your monthly payment would be $954.
Then, you decide to refinance your home loan after two years. Your loan balance is now $192,812. If you refinance for another 30 years at 4%, your new monthly payment would be $920. But, if you refinance at a 3.5% rate for 30 years, your payment would drop to $865.
4. Use Your Home Equity for Financial Goals
Refinancing can help you tap into your home’s equity, which can be useful for achieving your financial goals. Equity is the difference between your home’s value and your remaining mortgage balance. For example, if your home is worth $500,000 and you owe $320,000 on your mortgage, you have $180,000 in equity.
When you refinance and access this equity, you can use the funds for various purposes, such as:
· Using the equity as a deposit for buying an investment property.
· Purchasing land for future building projects.
· Funding home improvements or renovations.
· Taking out cash for personal expenses, such as a vacation or a new car.
5. Get Rid of Private Mortgage Insurance (PMI)
If your loan-to-value ratio (LTV) is higher than 80%, you may be paying private mortgage insurance (PMI) as part of your monthly mortgage payment. However, refinancing can help you remove PMI if your LTV drops below 80%. This may happen if your loan amount decreases, your home’s value increases, or both.
6. Change Co-Borrowers or Cosigners
If you originally took out a mortgage with a cosigner or co-borrower, like an ex-spouse, you can refinance and remove that person from the loan. On the other hand, if you want to add a new co-borrower, such as a new spouse with strong credit and income, you can do that. Adding them may help you qualify for better rates and loan terms.
Summing it up
So, refinancing your home loan is a great way to lower the overall interest repayment and consolidate your debts. However, it is important to have a look at the other side of the story. Refinancing a mortgage has some downsides to consider.
For example, one drawback is the closing cost, which may range from 2% to 6% of the new loan amount. These fees include appraisal, origination, and attorney fees and can vary depending on the lender. It is highly recommended to compare offers from different lenders to find the best deal.
Refinancing your home loan may affect your credit score. The hard credit inquiry and the closure of your previous mortgage account may cause a temporary drop in your score.