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Why (and why not) to refinance your mortgage

The possibility of refinancing your mortgage can seem like a lifeline at the worst of times, and a smart move at the best of times. On the surface of things, refinancing in order to lock in a lower interest rate can really save you money. Yet there are many factors you need to consider before taking the plunge. For one thing, it can cost you 3-6% of your principal loan and will require all-new application fees and a new appraisal. Ultimately, doing a bit of homework is key to determining whether refinancing is a wise move or not.

2 reasons to refinance

To reduce your interest rate. Generally, refinancing is considered smart if it means reducing your interest rate by 2% or more, although some lenders believe that 1% is reason enough. A lower interest rate can mean savings as well as a quicker road to building home equity. Sometimes dropping interest rates also present an opportunity to refinance in favor of a loan with a significantly shorter term—without changing the monthly payment much if at all. However, whether this will be beneficial or not depends on your current rate, so crunch those numbers and find out what works.

To switch between an adjustable-rate mortgage (ARM) and a fixed-rate mortgage. ARMs typically start out offering lower rates than fixed-rate mortgages, but over time these rates can increase significantly. On the one hand, switching to a fixed-rate mortgage can at times mean a lower interest rate and more peace of mind since you won’t be worrying about future increases. But on the other, switching from a fixed-rate loan to an ARM might be the way to go if interest rates are falling, particularly if you don’t plan to stay in your home beyond a few years—in this scenario, future increases won’t affect you anyway. 

2 reasons not to refinance

To tap into your home equity. Under certain circumstances harnessing your home equity can seem like a smart move. Maybe you need some extra dough to pay for needed renovations, start a business, or cope with an emergency expense. But if you’re not totally confident you can keep paying your mortgage in the long run, it’s probably better to leave your home equity out of it. You don’t want to risk losing your home for a temporary financial solution.

To consolidate debt. Many homeowners refinance to consolidate their debt. Unfortunately, this only works if you’re positive you can resist the urge to spend unwisely once refinancing relieves you from the pressures of multiple debts. Also worth considering is the fact that you may lose any special provisions on school debt—like interest rate discounts—when you consolidate debt.

Bottom line: only you can decide whether it’s a good time to refinance or not! If you need guidance, a savvy mortgage broker can also help you weigh the benefits against the risks and make a sound decision based on your unique goals and needs.

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