Getting into your own home is hugely satisfying. There is of course the mortgage to repay and getting it paid off as fast as possible is most home owners focus and if that’s not doable the next best goal is to be mortgage free by retirement. However, the reality is that life gets in the way, there may be additions to your family or a career move that shifts the goal posts on your debt repayment plans or you could be investing in a investment property and need equity for a deposit. So whatever the reason you may find yourself at some stage asking should you refinance or not and how does it affect your future debt-free goals. The starting point is understanding what refinancing means.
What is Refinancing?
Refinancing according to the Wikipedia definition is: ‘the replacement of an existing debt obligation with another debt obligation under different terms’. So you’re essentially replacing your current lender with another and taking your debt with you under different terms. You can change the amortization (a fancy word for paying off the debt over time), the amount you are borrowing, and the interest rate may change too.
It is important to note that refinancing usually has closing costs. Plus if you are breaking the terms of your current mortgage by paying it off early, you will likely need to pay off the interest still owing, or some kind of fee/fine. Even with these added costs, it can still make good financial sense to refinance.
Why Would Someone Want to Refinance?
Of course, the next question is why would someone want to refinance? There are actually a number of reasons homeowners turn to this option.
One of the most common reasons is to take advantage of lower interest rates. Perhaps you originally got a mortgage when interest rates were on the high side and now they have dropped. If they have even dropped by 1% it’s usually enough to equate to some significant savings. What this means is that the extra money will be staying in your pocket rather than going to the bank. Another benefit to a lower interest rate is that it helps speed up the rate that you can build equity in your house.
If interest rates are lower, this also gives people the opportunity to refinance for a shorter loan term. They can keep their mortgage payments the same, but since the rates are lower they will be able to pay it off that much faster. This is ideal for those who are comfortable with their current mortgage payment.
On the flip side, if the monthly mortgage payment is too high, refinancing gives you a chance to lower your monthly payment by choosing a longer term.
Another very common reason for refinancing is to consolidate debt. Perhaps you have a variety of outstanding debts such as a car loan, credit cards, a line of credit, etc. If each of those debts has a higher interest rate and you’re having a hard time juggling all the different payments, it can make sense to refinance for more than the existing mortgage and roll the rest of the debt in there. In order for this to happen, however, you will need to have built enough equity in your home.
So, while refinancing doesn’t suit everyone, it certainly has its benefits and advantages when it’s timed right and it can speed up the debt repayment shaving off months if not years of interest payments so you reach your mortgage free goal earlier than anticipated.