Homeowners refinance mortgages for a variety of reasons. Getting a better interest rate and changing the length of the loan are two main reasons. But perhaps the most common reason that homeowners decide to refinance their mortgages is to tap into the equity they have in their home, to pay for a wedding or college, to make home improvements, or to pay back higher-interest debt.
If you have equity in your home and you want to use that equity for any reason, now is the ideal time – in fact, one of the best times in recent history – to refinance and tap into your equity. Interest rates are near all-time lows, meaning financing a major life event, making home improvements, or paying off existing debt is especially attractive and affordable. Getting money back from the refinancing process is also known as "cashing out," meaning you're taking out some of your home's value in cash.
You can use the proceeds from your refinance to pay for any expense. But most experts agree, the best way to use your equity is to put it into something that will pay back over time. Paying for home improvements is a great example of using your home's equity to pay for a "product" – your renovated home – that will pay you back over time. In addition to enjoying the improvements your loan can yield, you also increase your home's equity. For instance, suppose you use $30,000 to improve your kitchen and bath, two areas of the home where improvements have the greatest impact on equity. Those improvements could increase the value of your home by at least $30,000, making them a fiscally responsible investment. And by increasing the value of your home with the latest improvements, you can also make your home more marketable, allowing it to sell more quickly – and for a higher price – if you decide to sell down the road. Of course, by increasing your home's value, you also increase the equity you have in your home, which means you may have additional equity to draw from in the future.
Some real estate investors use the existing equity in their primary home to finance the purchase of an additional home, either for resale or to use as a rental property for an additional stream of income.
Another wise use of your equity is to pay off existing loans that have high interest rates. By using low-interest mortgage money to pay off high-interest credit card or personal loan debt, you can save hundreds and even thousands of dollars compared to paying off a high-interest, high-balance credit card over time.
Refinancing can also pay for major life events, like weddings or college, allowing your child to move into the next stage of his or her life debt- and worry-free. Or it can pay for second (or first) honeymoon or other major, memorable event.
Of course, not every person who refinances cashes out equity from their home. Many homeowners refinance to obtain a mortgage with a lower interest rate than the rate they're currently paying. Experts used to say it was only worthwhile financially to refinance if the new rate was at least two percentage points lower than the existing mortgage rate. But with today's low, low rates and other incentives and discounts, that rule no longer holds true. Even a fraction of a percentage point can make a tremendous difference over the life of the loan. And since today's mortgage interest rates are near historic lows, the savings can be truly staggering in many cases.
Another possible reason for refinancing is to change the length of the loan. By lengthening the amount of time it takes to repay your mortgage, you can end up paying a significantly smaller amount of money each month. More commonly, mortgages are refinanced to accommodate a shorter term. While your payments may be higher each month, you build equity more quickly with a shorter term loan, and of course, you pay it off much more quickly, as well. In some cases, because interest rates are so low, your monthly payments may not be that much higher than they are with a higher interest rate and a longer term.
No matter what your reasons are for refinancing, if you need equity now or will in the near future, if you want to improve your home and its value, or if you just want to take advantage of all the financial benefits of having a lower interest rate and making a lower payment each month, now is the ideal time to refinance. But don't wait too long; eventually, interest rates will begin to creep up again, and while you may still achieve savings by refinancing your home, there's truly no time like the present to lock in an interest rate that is near an all-time low.
Summary: Experts used to say it was only worthwhile financially to refinance if the new rate was at least two percentage points lower than the existing mortgage rate. But with today's low, low rates and other incentives and discounts, that rule no longer holds true. Even a fraction of a percentage point can make a tremendous difference over the life of the loan.
Karen Zabel is a freelance writer who writes about a variety of topics including mortgage rates.
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