When you take out a mortgage, you don’t have to keep it ‘for life.’ If you come across lower interest rates, better terms or you have equity in your home, you may apply for a mortgage refinance. When you refinance, you break your current mortgage term and start another.
Let’s look at how it works.
What is a Mortgage Refinance?
When you refinance your home, you borrow money according to your home’s current value. You may borrow up to 80% of the home’s value, which sometimes puts more money in your pocket.
Home owners (the borrowers) refinance for the following reasons:
- Secure a lower interest rate – If rates drop lower than your current rate, you may save money refinancing. With less money going toward interest each month, you may pay your loan off faster, owning your home sooner.
- Change terms – If you have a variable rate you may refinance into a fixed rate term. With predictable payments, you can budget better and avoid higher rates during an increasing rate environment. Some borrowers even switch from a fixed rate to a variable rate in a decreasing rate environment to take advantage of the lower interest costs and higher principal payments.
- Tap into home’s equity – If you have large amounts of consumer debt or your home needs renovations, tapping into your home’s equity may help cover the costs. Whether you save money on high-interest consumer debt or you pay for needed home renovations, you may save money in the long-term.
How to Refinance my Mortgage
You have a few options when you want to refinance your mortgage.
Traditionally, borrowers break their current mortgage contract to take out a new loan. You may take out the new loan with any lender of your choosing. When you break your contract, make sure you know the prepayment penalty fees. For example, you may pay three months’ worth of interest or the IRD (Interest Rate Differential), whichever is higher if you break your contract. See your mortgage contract or contact a mortgage broker to assist you in understanding your situation.
While that sounds like a lot, if you compare it to the savings the new mortgage allows, you may see that it’s worth it. Look at the bottom line, not just the costs of the loan upfront.
Other options to refinance your loan include:
- Taking out a HELOC – If you have many uses for your home’s equity, you may consider a HELOC or revolving line of credit. This loan uses your home as collateral but gives you repeated access to the equity as you repay it (much like a credit card). A HELOC is a second loan on your property, separate from the first mortgage.
- Blended mortgage – If you need additional funds, but want to keep your existing mortgage, consider a blended mortgage. This option blends the rate between your current rate and the new market rate, giving you a rate in between the two while giving you access to your home’s equity.
Can you Refinance your Mortgage to Consolidate Debt?
If you have a large amount of high-interest consumer debt, you may use your home’s equity to pay it off. First, determine your home’s value. While you’ll need an official appraisal if you refinance, estimating the value for the time being works.
Once you know your home’s value, multiply it by 80%, as that’s the maximum amount you may borrow. If your home is worth $350,000 for example, you may borrow up to $280,000. Now compare that to your current outstanding balance. Do you have room to wrap your credit card debt or personal loans into it?
If you do, you may benefit from lower interest rates, paying the principal balance off faster, rather than paying excessive interest fees.