Debt can sometimes give us the impression we’re sitting on a house of cards that can crash at any moment. A quick shift one way or the other feels like it could be financially catastrophic. In the thick of frantically trying to balance the bank account, like an unsteady hand trying to stack the last two cards, a bright idea pops into mind: refinance.
Before jumping into refinancing your home, make sure it’s the right avenue for you. A brief pause could prevent further debt and the house of cards from flying everywhere.
How it Works
At its core, refinancing is trading your current mortgage for a new one. The lender would then pay off the old mortgage with the new one, leaving you with one monthly payment. Ultimately, your goal is (usually) to end up with a lower monthly payment because of a lower interest rate, a lower principal balance or a shorter loan lifespan.
A number of reasons will compel someone to explore refinancing options. It’s important to clearly establish your goals before choosing a path. A relief in monthly payments today, will likely create more payments tomorrow. On the surface some options may seem more appealing than others depending on your current financial situation. Understanding your reason for refinancing can stack the cards in your favor.
- Change loan term — If you can afford to take on a higher payment and you’re looking to shorten your loan term to save on interest, this is a viable option. Or this can be used to do the opposite and lengthen a loan term for lower monthly payments.
- Change loan type — This can be a great option if you have an adjustable-rate mortgage (ARM) and the interest rate is starting to creep up. A different loan type can put you into a fixed-rate mortgage to lock in that interest rate.
- Lower interest rate — A number of circumstances can change the interest rate you originally obtained for your mortgage. If you qualify, it could mean lower monthly payments and less interest over the life of the loan.
Loans to Explore
Now that you understand your why for refinancing, it’s important to understand some of the nuances of each one. Be sure to consider the pluses and minuses of the new debt terms you’re jumping into.
HELOC — Home equity line of credit
Also known as a second mortgage, this option is a line of credit you can take from that is secured by your home. These are delivered in two phases: the borrowing phase and repayment phase. Typically these come with variable interest rates, so be sure to understand how much variation it brings.
The plus side is the ability to borrow what you need, when you need it, and only having to make payments on the interest. The minus is how drastic the payments can change, depending on the variable interest rate, during the repayment phase.
Home equity loan
Another second mortgage option is a home equity loan, routinely a fixed-rate loan, distributed as a lump sum. To be clear, this loan type does not replace your existing mortgage. It adds to your current debt, but depending on the interest rate and repayment plan it can be extremely helpful in paying off other debts to consolidate.
The plus is that it can be a low cost way to borrow cash. On the minus side the payments can’t be missed. Otherwise, your home is on the line.
Secured by the real estate itself, this loan is relatively low-risk to lenders and creates lower interest rates than most types of debt. This is a logical option if you need a lower monthly payment or have a goal to pay off the home faster because of a new financial situation.
On the plus side, you could pay off the loan faster by shortening the terms of repayment, but it’ll come at a higher monthly cost. Or you can do the reverse if you need more monthly capital.
The minus side is that the savings could be minimal or you run the risk of not breaking even. Check to see if there are closing costs involved and factor them into the overall decision. It could save you a lot of time, effort, and dollars.
Maybe you need cash-in-hand now. This option replaces your old mortgage amount with a bigger new one and you get to walk away with the balance. The plus side of this option rests with your ability to repay the new terms of the loan. If it’s not a problem, this can give you better mortgage terms with money to repay other debts. The minus is high upfront costs and missing payments will inevitably lead to losing your home.
When you look at your financial situation, don’t stack cards with shaky hands. Take a deep breath and a hard look at options that can turn your home into a financial tool. No two debts are the same, so if you’re unsure, get a professional involved. They can help guide you in the right direction and transform that house of cards into a solid foundation.