Key takeaway

Refinancing your mortgage may have several potential benefits: It could reduce your monthly principal and interest payment or it could help you pay off your mortgage faster. You’ll want to review any costs associated with the refinancing, as well as the new interest rate of your loan, to determine if a refinance might make sense.

Depending on when you purchase your home, you may notice that interest rates go up or go down in the months or years after you secure your mortgage. Additionally, you may find that your credit score changes — perhaps it goes up based on smart financial decisions you’ve made around your debt.

If rates are lower, or you think your credit rating may qualify you for a better interest rate than you received when you first got your mortgage, you may consider refinancing. A refinance is essentially getting a new mortgage to replace the one you currently have. Read on for information on when refinancing your mortgage may benefit you.

Why refinancing your loan could make sense

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To get a lower interest rate

When you’re making mortgage payments, you’re paying against the principal and the interest your lender charges on the loan. The lower your interest rate is, the less you’ll pay in interest over time. This can mean you pay more of the principal loan amount each month to pay off your mortgage more quickly, or that you free up more of your monthly budget for other day-to-day expenses or for saving for future goals.

Taking advantage of a lower interest rate is the #1 reason homeowners refinance their mortgage, according to the U.S. Census Bureau.

Source: American Housing Survey, 2019

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To reduce the time frame of your mortgage

You may be able to refinance to reduce the amount of time it will take to pay off your mortgage. For example, if you had 22 years left on your initial loan, you may be able to refinance by choosing a 15-year or 20-year mortgage. It’s important to review the impact this may have on your monthly principal and interest payment, however. Shortening the length of your mortgage may make your monthly payment higher, depending on the interest rate and other factors.

Source: Freddie Mac 2020 Q1 Refinance Report

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To switch from an adjustable rate to a fixed rate 

If you have an adjustable-rate mortgage (ARM), the interest rate can go up or down over time based on market conditions. If you have an ARM and you expect interest rates to go up, you may consider refinancing to lock in a fixed rate, especially if rates are low.

Source: 2019 National Association of REALTORS® Research Group Home Buyers and Sellers Generational Trends Report

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To eliminate mortgage insurance 

Mortgage insurance, also known as private mortgage insurance (PMI), is designed to protect your mortgage lender if you stop making payments on the home as agreed. It is required on certain types of loans, including often on conventional mortgages when your down payment is less than 20% of the home’s purchase price.

Depending on the type of loan you have, the amount you have remaining to pay on your mortgage, and your home’s value, refinancing your mortgage may help you get a mortgage without needing PMI. Typically lenders want you to have at least 20% equity (the difference between the appraised value of your home and what you owe on your mortgage) in your home to avoid paying PMI. Every lender is required to automatically cancel PMI when your principal balance either reaches 78% of the original value of the home or when you have made on-time payments for half of the period on the loan term (e.g., 15 years on a 30-year mortgage).

Source: Investopedia

PMI typically costs between 0.5% and 1% of the entire loan amount annually
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Refinancing may not always be a good strategy

Even if you may be able to refinance your mortgage at a lower interest rate, refinancing may not always save you money. That’s because extending the loan term or borrowing to pay the closing costs of a refinance could outweigh what you’d save with the lower interest rate.

It also may not be worth it if you’re planning to move soon, as the savings in a refinance are often realized over the long term. Ultimately, your refinancing decision may rely on what you hope to achieve through the refinance. A home mortgage consultant can show you the impact of a refinance on both a short-term and long-term basis to help you make your decision.

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