The smart homeowner’s guide: 4 benefits of refinancing your home loan

What does refinancing a home loan mean and why is it important?

4 benefits of refinancing a home loan

Before diving into the benefits of refinancing a home loan, it’s essential to first address the cons of refinancing a mortgage. While the advantages of refinancing can range from lower interest rates to shorter loan terms, there are also situations where the costs or risks may outweigh the benefits.

For instance, if you plan to sell your home soon, there may not be enough time to recoup the upfront closing costs of refinancing, which generally range from 2% to 6% of the loan amount. These can include both percentage-based fees and fixed costs such as appraisal fees or attorney fees.

Additionally, refinancing can restart the loan clock, meaning you might end up paying more interest over the life of the loan, even if your monthly payments are lowered. Those with poor credit scores or little equity may also be subject to unfavorable terms or higher interest rates.

For more considerations on whether you should refinance, review the United States Consumer Financial Protection Bureau’s article on Should I Refinance?

By carefully considering these factors, you can ensure that your refinancing lines up with your financial goals and doesn’t result in any unnecessary costs or complications. Now, let’s jump into the five key benefits of mortgage refinancing to see how they can best work to your advantage.

1. Lower interest rates & monthly payments

One of the primary reasons why people consider refinancing a home loan is to secure lower interest rates, which can directly reduce the amount due for monthly payments. This can also provide immediate financial relief as well as result in tens of thousands of dollars in savings over the life of the loan.

So how does refinancing work to lower interest rates? To start, lenders will assess your credit score, loan-to-value-ratio and market conditions to determine your new interest rate. Homeowners with improved credit scores, or a significant drop in rates due to market conditions, have the potential to create the largest reduction in interest rates.

For example, if you refinance a $300,000 mortgage from a 6% interest rate to 4%, then monthly payments could drop by over $300. This would save more than $100,000 over 30 years.

2. Shortening the loan term

If you are aiming to pay off your mortgage faster, then refinancing to a shorter loan term (e.g. switching from a 30-year to a 15-year loan) can be a smart option.

When choosing to refinance your home loan, you have the option of switching the loan terms to a shorter term. This is a commitment to repay the loan over a shorter period, in turn prioritizing long-term savings and financial independence over the short-term monthly affordability.

However, this can come with a few key implications:

• Higher monthly payments: With fewer years to repay the loan, your monthly payments may increase.
• Lower total interest paid: Shortening a loan term could reduce the overall time your loan accrues interest, so you end up saving a significant amount on the overall interest paid in the long-term.
• Faster equity build-up: Paying off principal more quickly could help build equity in your home at an accelerated rate, which is beneficial for those planning to sell their homes or aiming to leverage the equity for future needs.

For further reading on loan terms, review the U.S. Consumer Financial Protection Bureau’s page on the Different Kinds of Loans to understand loan types, terms and interest types.

3. Switching from adjustable-rate to fixed-rate mortgage

One of the most common reasons for refinancing a home loan is to shift from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. This can help ensure stable, predictable payments, especially when market rates are volatile.

The key difference between an adjustable-rate mortgage (ARM) and a fixed-rate mortgage (FRM) revolves around how the interest rate is structured and whether it changes over time. The interest rate on an ARM can change periodically based on market conditions, typically starting with a period of fixed interest (e.g. 5 years).

Once the fixed period ends, the rate can increase significantly, leading to higher monthly payments. An FRM has a consistent interest rate for the entire term of the loan, meaning your monthly principal and interest payments remain predictable.

So, when should you switch from an ARM to an FRM? If market interest rates are increasing, or expected to increase, then the variable nature of an ARM can result in higher monthly payments after the initial fixed-rate period ends.

Additionally, if your initial fixed-rate period is ending, then refinancing before the adjustment phase begins can help ensure stability and avoid any sudden increases in monthly payments.

Finally, if you plan to stay in your home long-term, switching to a fixed-rate mortgage can offer predictability and stability for the future. Use our calculator tool to determine What Will My Fixed-Rate Monthly Mortgage Be?

4. Accessing home equity through cash-out refinancing

A cash-out refinancing allows you to draw from your home’s equity to cover any major expenses, consolidate debt or invest in improvements. So how does a cash-out refinancing work?

Cash-out refinancing allows you to replace your current loan with a higher loan amount, receiving the difference in cash. For example, if you owe $200,000 on a $400,000 home loan, you may refinance for $250,000 and take the $50,000 in cash to cover major expenses.

Some smart uses for money gained from a cash-out refinancing include home improvements that increase property value, debt consolidation to reduce high-interest credit card payments, or education expenses and/or other significant investments.

Everything you need to know about mortgage refinancing

Refinancing your mortgage can come with a variety of upfront expenses, including appraisal, title and closing fees, which together typically amount to 2% to 6% of the new loan amount. While some of these costs are tied to your loan size—such as origination fees—others are fixed charges, like an appraisal or title services, which vary by location and provider. While these expenses can add up, refinancing can often lead to long-term savings by securing a lower interest rate or better loan terms.

A common concern is whether refinancing negatively impacts your credit score. While the process does involve a hard credit inquiry, which may cause a temporary dip in your score, consistently making on-time payments on your refinanced loan can improve your credit over time. If your credit score is low, you may still qualify for refinancing, but expect to receive higher interest rates. Some lenders offer programs for borrowers with less-than-perfect credit, though it’s always good to improve your score before applying to secure better terms.

Determining the right time to refinance depends on several factors. It's often most beneficial when interest rates drop significantly or your credit score improves, allowing you to qualify for better loan terms. Keeping an eye on current lender rates can help ensure you make a well-timed, informed decision.

If you’re considering refinancing, be prepared for the process to take anywhere from 30 to 45 days, depending on the lender and the complexity of your application. Understanding these key factors can help you determine whether refinancing is the right financial move for you.

Unlock financial growth with smart refinancing decisions

Refinancing your home loan offers various financial advantages that can help improve your personal finances. Whether it is securing lower interest rates or shortening your loan term, there are various strategies to help you reduce costs and save money over time. Additionally, the flexibility of cash-out refinancing can provide powerful tools to address immediate and long-term financial goals.

Refinancing is not a one-size-fits-all solution. It’s a strategic decision that should align with your personal and financial objectives, considering factors like your current financial situation, plans for your home and potential costs involved. To make the most informed decision, it’s always a good idea to consult with trusted lenders or financial advisors before potentially incurring unnecessary risks.  With careful planning and expert guidance, refinancing your home loan can unlock new opportunities for financial growth and security. Reach out to one of our local branches to find a mortgage specialist who can answer questions and help get you started.