There are many reasons to refinance your home, but they all boil down to one key goal: saving money. You might be trying to lower your monthly payment, pay less mortgage interest, erase high-interest debt or get rid of private mortgage insurance (PMI).
Refinancing can have both short- and long-term effects on your finances—some good, some bad. We’re going to focus on four good long-term reasons to refinance your home. Why? Because thinking only about the short-term benefits of refinancing can be costly and actually set you back in the long run. To illustrate this, we’ll also discuss four bad short-term reasons to refinance your home.
4 Best Reasons To Refinance Your Mortgage
There are at least four excellent reasons to refinance your home:
- Increase long-term savings
- Pay off credit card debt
- Get rid of PMI
- Refinance out of an FHA loan
You might already be quibbling with some of these. Don’t worry—we’ll be taking a nuanced look at the potential downsides of these reasons, as well. But, in fact, there is good cause to refinance under these rationales.
1. Increase Long-Term Savings
Refinancing can help you increase your long-term savings in two main ways:
- A lower interest rate can decrease the mortgage interest you pay over the life of your loan.
- A smaller monthly payment—which may mean you’ll be paying a mortgage for longer—can allow you to save and invest more for retirement now.
The first is a sure thing. The lower your mortgage interest rate and the faster you pay off your home, the less interest you will pay. Don’t forget that closing costs for each mortgage you take out are part of your long-term borrowing costs, too.
The second involves more risk. The younger you are when you save and invest for retirement, the more opportunity you have for extra years of compound returns to add up to far more than the interest you would save by paying down your mortgage quickly. Remember, though, investment returns are never guaranteed.
That makes paying off your mortgage a safer “investment” than the stock market in that your return—having a paid-for home—is guaranteed. If you need to, you can unlock that equity in retirement with a cash-out refinance, home equity loan or reverse mortgage.
Still, if you focus intently on paying off your home instead of refinancing into a smaller monthly payment, you may sacrifice maxing out your retirement accounts to do so, meaning you may lose the advantage of time with this strategy.
Sure, you’ll have a paid-for home, and with no mortgage payment, you can accelerate your retirement savings at that point. But you can’t get back the years of missed contributions and potential investment growth. Even if the market performs poorly for years, you will have missed the opportunity to buy stocks at low prices.
Many retirees, while rich in home equity, are poor in monthly cash flow. Being secure in your residence is a good thing, but it’s not as good if you don’t have the cash flow to pay for property taxes, maintenance, homeowners insurance and necessities unrelated to owning the house itself.
2. Pay Off Credit Card Debt
Paying less interest on consumer debt, such as credit cards and personal loans, is also a good way to increase long-term savings. But when people think about refinancing to reduce interest on consumer debt, they often think about doing a cash-out refinance and using the cash to pay off their debt.
Is this actually one of the best reasons to refinance? Honestly, it can also be one of the worst. It really depends on you.
- Will you reduce your home equity by cashing out, pay off your high-interest debt, then get back into consumer debt again? If your financial situation is unstable, you don’t have a multi-month emergency fund or you don’t have self-discipline, you might end up with more debt than you started with. Bad luck or bad behavior can mess up this strategy.
- Alternatively, will you never get back into consumer debt again and enjoy the interest savings by paying off your past mistakes at the much lower rate you can get on a new mortgage instead of the high rate you’re paying now?
If you’re carrying a lot of debt, it’s possible that your credit score is too low or your debt-to-income ratio is too high to qualify for a refinance—or that you won’t get the best mortgage rate. (Don’t assume anything without exploring your options for getting a mortgage with bad credit, though.)
Make sure to look at the big picture, too. When you refinance debt at a lower interest rate and repay it over 15 or 30 years, you’re not necessarily going to come out ahead. Attacking your debt with the snowball or avalanche method can be cheaper and more effective.
3. Get Rid of PMI
If you’re carrying private mortgage insurance, or PMI, you know that it’s costing you money every month. Once you have 20% equity in your home on a conventional mortgage, you can ask your lender to cancel PMI as long as you have a good payment history, you’re current on your mortgage, there aren’t any liens against your home and your home hasn’t declined from its original value. Once you have 22% equity, your lender is required to cancel it as long as you’re current.
What if you want to get rid of PMI sooner? Refinancing might be one way to do it. But since you’ll have to pay closing costs to refinance, it might be a costly way to get rid of PMI. Refinancing to get rid of PMI might not be worth it unless it’s giving you other benefits, like a lower interest rate, and unless the break-even period is short enough. How much will you pay to refinance compared to how much you’ll pay in PMI before your lender will cancel it?
Plus, paying down your mortgage isn’t the only way to reach 20% equity. If home values have increased in your market, you might be able to reach 20% equity faster due to home price appreciation, and you may be able to ditch PMI without refinancing. You might have to pay a few hundred dollars for a home appraisal, but that’s a much cheaper and easier option than refinancing.
4. Refinance Out of an FHA Loan
If you’ve taken out an FHA loan in recent years, you know that you’re stuck paying mortgage insurance premiums for either 11 years or the life of the loan, depending on how big your down payment was. That’s a long time to pay those premiums.
Since you can’t ask your lender to cancel FHA mortgage insurance once you have 20% equity, refinancing may be the only way to get rid of it.