Want to improve your finances? There are many ways to accomplish this, but if you're a homeowner, one of the best and easiest might be refinancing your mortgage. Most homeowners refinance to lower their interest rates, but there are additional ways to increase your bottom line with a mortgage refinance.
You may be able to reduce your monthly payment by replacing your old mortgage with a new one. This is possible if interest rates have dropped, or you choose a different product (perhaps a 5/1 ARM instead of a 30-year fixed mortgage), or you extend your repayment period. If you're five years into a 30-year loan and refinance into a new one, even at the same rate, your payment will drop. That's because your balance after five years is lower, but you're repaying it over a new 30-year term. This effect is even more pronounced if you replace a 15-year mortgage with a 30-year loan. Note that extending repayment adds to the interest paid over the life of the loan.
Why reduce your payment? If you're having difficulty affording your home, or you need to put more money toward investments or paying off high-interest accounts, it can make sense to lower your payment -- even if you increase your interest expense over the life of the loan.
If your goal is to pay less interest, there are a couple of ways to do that. One is refinancing your mortgage into the same loan with a lower refinancing rate. Starting a new loan with the same term adds to the total interest paid, but that can be offset by paying a little extra each month to retire the mortgage on time. So if you're five years into your 30-year loan and refinance to a new 30-year loan, use a mortgage calculator to determine how much to pay each month to zero your balance in 25 years -- or simply ask your lender for a 25-year loan.
Homeowners who don't mind higher monthly payments can refinance from a longer repayment term to a shorter repayment term such as a 15-year mortgage. Shorter loans not only reduce your repayment period; they come with lower interest rates. Homeowners wishing to retire mortgage-free may choose a 15-year term to help support their retirement goals.
Fix an ARM
Refinancing from an adjustable rate mortgage to a fixed rate loan stabilizes monthly principal and interest payments, and eliminates concerns about potential upward rate adjustments. You can gain peace of mind by refinancing to a fixed mortgage when rates are low. While this may increase the monthly payment now, it does make budgeting easier and protects you from increases in the future.
Cash-out refinancing means replacing your old mortgage with a new, larger one, and taking the difference in cash. It may seem counter-intuitive to improve finances by adding more debt. However, you're not really adding to your debt if you use that cash to consolidate high-interest accounts. Keep in mind that just because the credit cards are zeroed out doesn't mean you're out of debt. Don't consolidate debt this way unless you know you won't start carrying credit card balances again.
The Federal Trade Commission cautions borrowers to consider their reasons for a cash-out refinance, as it increases the mortgage amount and reduces home equity. Homeowners often use cash-out refinancing to fund home improvements. Improvements should be chosen carefully, as some increase the home's value more than others, delivering a higher return on investment (ROI). Homeowners should be careful not to over-improve their property to the point that it no longer fits in with the neighborhood, or they won't get the increase in home value they hope for.
Evaluate Your Options
You have a better shot at accomplishing your refinance goal if you don't over-pay for your home loan. The Federal Trade Commission encourages consumers to "shop, compare and negotiate" to get the best deal on their refinance mortgage. Consider various refinancing options and compare several mortgage quotes before committing to a program.