Financial Answer Center

Reasons to Refinance Your Mortgage

There are three main reasons that may motivate you to refinance your existing mortgage. One is to save money because interest rates have dropped below the rate that you currently have on your mortgage loan. Another reason is to raise capital, borrowing additional money from the equity in your home during the refinancing process. A third reason to refinance is to get into another type of loan, for example when a balloon mortgage comes due.

Declining Interest Rates

Anyone who has ever obtained a mortgage loan will probably agree that one of the most nerve-wracking experiences in their life was watching mortgage interest rates ebb and flow as they gambled on when to lock in a rate on their loan.

Interest rates have historically been very volatile. At times, the mortgage industry has been quite competitive and homeowners have been able to obtain competitively low rates and costs. At other times, credit has been very tight and mortgages have been hard to obtain at any rate.

Raising Capital

You may be able to borrow money as part of the refinancing process, provided you have enough equity in your home; this process operates much like a home-equity loan. This can make good financial sense, because under most circumstances, mortgage interest is tax-deductible. The best part is that, in times of declining mortgage rates, you may be able to keep your monthly mortgage payment the same as before you refinanced, even though you have borrowed some cash.

Here's an example of refinancing when interest rates have declined since the time the existing mortgage was taken:

* Provided you have enough equity available—see the section The Process of Refinancing.

As you can see from the above example, when you refinance your current mortgage at a lower interest rate, you can borrow an additional $14,083 and still keep the same monthly payment. Here are a few good reasons to raise capital through refinancing:

• financing improvements to your home;
• consolidating debts: paying off higher-rate consumer debt, such as credit cards, or an auto loan; or
• starting a business.

If one of your reasons was to pay for a vacation, you are not on the right track. Remember that you could be jeopardizing the security of your home by frivolously increasing mortgage debt.

Refinancing to raise capital makes sense if you want to keep your loans consolidated and have one monthly payment. It also gives you the benefit of being able to spread the payment out over a longer number of years if you need to.

IMPORTANT NOTE: Although a longer payment period keeps your monthly payment lower, it increases the total cost of the mortgage.

Be careful not to overextend yourself and be sure to plan for emergencies. See the section Taking Out a Home Equity Loan. This section also contains examples that can help you determine if you can take out additional money when you refinance.