Paying the monthly mortgage is for some people the biggest monthly expense they have to meet, and while many homeowners depend on a mortgage plan to afford to live in their houses, others wouldn’t mind trading off some equity for saving a bit of cash.
So when is the best time to refinance a mortgage? Refinancing a mortgage is sometimes a pretty smart strategy to make some extra cash or pay off high-interest debts. This only happens if you study this action before attempting to do it, and get well prepared for it. These are the most common reasons for wanting to refinance a mortgage:
- When You Want to Lower Your Interest Rate
- When You Need to Switch Between Interest Plans
- ‘Take Out’ Cash from Your Home
While some may understand how this game works, others might get really overwhelmed by how complicated the whole business is.
But this doesn’t have to be the case here, and with that said, I’ll be taking responsibility to teach you is the best time to refinance a mortgage, and all the precautions you should know first. Let’s dive in.
What Is a Mortgage?
Before answering the main question, you need to catch up with the meaning of mortgage first, since we’re going to need this in the process.
As we all know, a mortgage is a legal insurance measure, in which banks or other similar entities, lend you money, and hold in a proprietary right to a collateral asset of yours, which is usually a house, commercial asset or any real estate property.
In fact, this is just the most common form of a mortgage. However, other types of mortgages exist that you can check here.
Many people opt for a mortgage instead of a house loan or rent, as a mortgage wouldn’t only offer more money than a loan but also, every time you pay the monthly interest, you actually turn some of your debt into equities.
This means that you own a little more of your house with every monthly payment you make to the bank, and it’s definitely better than paying rent to a landlord without ever owning the house you live in.
So, What’s Refinancing a Mortgage?
Alright, now that we agree on a mutual understanding of what a mortgage is, it’s a perfect time to introduce the basics of mortgage refinancing.
One way to define refinancing a mortgage in the shortest way possible, is to get a new mortgage loan, and use it to pay for the older one, which is done for a variety of reasons.
This money can be used to pay off other debts, renovate a house before selling it for a bigger profit, start a new business, or add it to a savings account.
The possibilities for a successful deal are unlimited, but also the chances you might slip into a never-ending loop of paying debts are higher than you can imagine.
What Are the Best Times to Refinance a Mortgage?
Finally, coming down to the golden question we’ve been building up for. Refinancing is done by different people for different reasons, and we’ll be discussing them all to see if any of these reasons fit your criteria.
When You Want to Lower Your Interest Rate
One of the smartest and most common reasons people tend to regard refinancing their mortgage is to lower the interest rate of their payments.
An interest rate is basically what dictates the amount of money you need to be paying back to the bank at the end of every month, and since it’s always better to pay less for the same property, most of the mortgage refinancing happens for the exact reason.
Interest rates aren’t always constant, and their fluctuation is controlled by many factors, including changes in the government’s financial policies in response to global and local market status.
To take the move of refinancing into account, the government’s prevailing rate of interest needs to be going lower than your current mortgage interest rate by an average between 1% to 2% as recommended by many experts.
Refinancing at a smaller margin is highly discouraged, as it may lose you more money than it makes.
That’s why if you’re interested in investing your ongoing mortgage, you really need to keep an eye on your current interest rates and see if changing your plan is going to be of any benefit to you.
When You Need to Switch Between Interest Plans
Some people tend to refinance so they can alter their mortgage plan between an adjustable mortgage rate and a fixed mortgage rate. This happens for several causes, and since switching to each side has its pros and cons, we’ll discuss them both.
Switching from Variable to Fixed Interest Plans
First, we’ll discuss converting to fixed ones, as it’s more popular. When new mortgage takers are offered to choose between variable and fixed mortgage plans, they find that variable rates are lower than the fixed ones.
Naturally, they get lured into choosing a variable plan without a second thought. What happens after is that those variable rates can go up and even exceed the fixed interest rates due to cyclic changes.
At that time they rethink their variable interest rate plan and try to refinance their mortgage into a fixed-rate system, by doing so, they choose a safer path, avoiding any future interest fluctuation.
Moreover, just as the variable rates fees get higher, they’ll find themselves paying less mortgage interest fees, making the switch a successful future-proof deal.
Switching from Fixed to Variable Interest Plans
On the other side, different homeowners who aren’t intending to live long in one specific house, and are willing to move out in a couple of years, can benefit from having a variable interest rate on their mortgage.
This happens because as we mentioned, variable interest plans start out at a lower interest rate, given that interest rates are also generally falling, they can save up a large sum of money on the go by rooting for an adjustable interest rate.
‘Take Out’ Cash from Your Home
Many people encounter the fact that the values of their houses have gone up while they’re still paying for the old price, and since any additional increase in the value of your property is considered equity, some people are tempted by the idea of cashing out this extra money.
While the previous reasons were more functional and felt more considerably logical, given that time and conditions were right, this approach can be quite a dangerous one.
What property owners need to know is that there is always an actual trade-off when it comes to taking equity value of your house. Banks are smart and they’re well aware of the fact that houses will eventually have a higher value than the loan they gave.
That’s why they came up with the prepayment policy, which is a previously agreed on penalty, either specific or relative amount of money that you’ll have to give to the bank if you pay off your loan ahead of the expected schedule.
As you could figure, sometimes the value of the prepayment penalty along with additional bank fees and the mortgage brokers’ expenses can actually exceed the profit made from refinancing your mortgage, or close enough to make it not worth the hassle.
Consequently, if you’re ready to take this route, you have to comprehend the benefits and risks coming from this move. You also need to be well prepared for these fees, in addition to carefully choosing the best mortgage option beforehand.
When Shouldn’t You Refinance Your Mortgage?
Our golden rule of thumb here lies in considering this step only if you have a perfect credit record as well as being debt-free, but there might be some ways where you can get a mortgage with bad credit.
Among the things you can do to see if refinancing is any good to you is to measure how long it’ll take you to reach out for a professional so you can calculate the break-even point.
The break-even point is an economic term that defines the point when your new mortgage monthly fees are equal to your savings. In short, how long until your refinancing pays for itself.
This might sound easy, but it’s not always the case, and you’ll be surprised by the amount of time this method advises them not to refinance.
Another way to put it, don’t attempt to do any refinancing if you don’t need the money dearly, or you’re going to spend the equity money on materialistic stuff.
Poor planning or execution can easily lead to losing your house as much as good planning can earn you a new one.
What to Do If You Decide to Refinance Your Mortgage?
So let’s say that you’ve done your homework, and you’ve reached the final decision to refinance, then the first thing you should be doing is to consider how you’re going to pay off the new mortgage.
That’s because if you have a property at a specific price, and then its value has grown to double the original value, cashing out the extra money will only result in forcing you to pay for double the monthly fees you were used to paying.
So it’s crucial to know how you’re going to repay, and what your actual intentions are behind refinancing your mortgage. If you’re only doing it to lower the monthly rate, without drawing any equity of the house, then that’s just a smart play.
We sincerely hope our article was able to give you a better understanding of when and why you should consider or avoid refinancing a mortgage.
Remember, careful planning and consulting a mortgage broker about the whole situation are required before risking anything valuable, as what is being put on the line here is the very exact thing that provides you shelter and peace of mind at night.