What is Loan Refinancing?
Loan refinancing occurs when the terms and conditions of a loan — such as the interest rate or payment schedule — is revised. The new loan that you get is called the “refinance loan.”
There are a number of reasons why people choose to refinance their loans. For one, they might want to take advantage of lower interest rates. Or they could be looking for a loan with more flexible repayment terms. Some people also use refinancing to cash out equity from their home.
If you’re looking to refinance your home loan, you’ll need to approach a lender and complete an application. The lender will then appraise your home to determine its current market value. They’ll also take a close look at your credit score, employment history, and debts to determine if you’re eligible for refinancing.
Now that we know what refinancing is, let’s take a look at the benefits of refinancing your home for improvements.
What are the Benefits of Refinancing your home for Improvements?
Home loan refinancing offers several benefits, including the ability to take advantage of falling interest rates, switching to a fixed interest rate, and the chance to eliminate private mortgage insurance. Let’s discuss these in detail.
1. It Lets You Take Advantage Of Falling Interest Rates
If you took out your loan at a time when interest rates were high and have fallen since, refinancing can help you lower your monthly mortgage payments and save hundreds of dollars per month.
The exact amount of money you’d save will depend on the percentage points that the interest rate has fallen by. But as your mortgage loan is a large sum spread over several years, even a minor drop in the interest rate can translate into significant savings.
For instance, if you’re refinancing a $300,000 loan to reduce your interest rate from 5% to 4%, you’d save around $170 every month. In this case, only a 1 percent drop in the interest rate can accumulate over $20,000 of savings over 10 years, which is a lot.
For an accurate picture of how much you’d have to repay on your loan without refinancing, you can use this calculator.
2. It Might Eliminate Your Private Mortgage Insurance
Depending on your mortgage, if you financed more than 80% of your home’s value, you might be paying private mortgage insurance (PMI). In this situation, refinancing your mortgage once you reach 20% equity in your house will eliminate the PMI.
This is true for most loan types, including certain FHA home loans. Cutting this expense through refinancing will further decrease your monthly mortgage payments.
The money you save by eliminating PMI might not be a lot but it will add up to a significant sum over the years.
3. Saved Money Can Be Spent Elsewhere
Whether it’s the cash-out refinance or the renovation refinance you’re going for, one thing is certain: you’ll end up saving a lot of money (only if you can get a lower interest rate, of course).
The money saved can be used to finance some worthwhile home improvement projects. These might include repainting your house, sprucing up your house’s interior, upgrading to smart home technology, getting new flooring, buying new appliances, or even expanding your house to accommodate more people.
For any leftover money, here are some financially prudent ways to spend it:
- Paying for your child’s college education
- Repaying your student loan
- Investing it — buying an investment property, for example
- Allocating funds for emergencies
- Paying your credit card’s outstanding balance
- Adding money to your retirement fund
4. It Allows You To Switch To A Fixed Interest Rate
Borrowers with adjustable-rate mortgages (ARMs) can face increasing monthly mortgage payments if the interest rates rise.
A sudden increase in your monthly expenses isn’t easy to manage. One way to avoid this uncertainty is to refinance before your rate increases. So, if your rate adjustment period is approaching and it’s apparent that your rate might increase (or you can get another loan for a lower rate), then you should definitely consider refinancing to a fixed-rate loan.
Switching to a fixed-rate loan will ensure that you pay the same fixed interest rate for the rest of your loan’s life. This will make your mortgage payments more predictable and manageable.
5. It Gives You The Option To Change Your Loan Term
One major benefit of refinancing is that you get the option to change your loan term.
The 30-year plan is the most common loan term that people opt for. When their income increases later in life, they often want to repay their debt sooner.
Refinancing your home for improvements gives you the opportunity to do this. For example, if you initially had a 30-year plan, you can reduce it to a 15-year plan via refinancing. This will also save you from paying a significant amount of money as interest.
But keep in mind that reducing your term will increase your monthly mortgage payments. If you think reducing your term by half might be unaffordable at the moment, consider reducing it to 20 years instead.
Eligibility Criteria For Refinancing
Before you can enjoy the benefits of refinancing, you must be eligible for it. Below are some prerequisites that you need to fulfill to secure a loan refinance.
- You have sufficient home equity.
Most lenders require that you have at least 3% to 3.5% equity in your home.
- You’re maintaining a credit score of more than 600-620.
This can vary depending on the lender and your loan type. A score of 700 or above can get you lower interest rates.
- Your debt-to-income ratio is low.
Your monthly debt repayments should be no more than 43% of your gross income.
- You can afford the cost of refinancing.
Refinancing costs usually amount to 3-5% of the loan amount. However, these costs can vary depending on factors like your credit score.
What Are The Types Of Loan Refinancing?
There are several types of loan refinancing, each with different purposes. They are cash-out refinancing, rate-and-term refinancing, cash-in refinancing, and consolidation refinancing.
- Cash-out Refinancing
This occurs when an asset that collateralized the loan increases in value. This allows you to withdraw the increase of your equity in the asset in exchange for a higher loan amount. You’re still able to maintain the ownership of the asset while getting immediate access to a substantial sum of money.
- Rate-and-term Refinancing
This type of refinancing is undertaken to get a lower interest rate or to change the loan term. It doesn’t involve taking out any additional cash.
- Cash-in Refinancing
This is the opposite of cash-out refinancing. In this case, the borrower makes a larger down payment to secure a lower interest rate.
What Are Some Other Ways To Fund Home Improvements?
You don’t have to give up on home improvement projects just because you can’t afford a loan refinance. There are other ways to finance your home renovations.
For starters, you can take out a home equity loan or a home equity line of credit (HELOC). These are both loans that use your home equity as collateral.
A home equity loan gives you a lump sum of cash that you can use for home improvements. A HELOC, on the other hand, gives you a line of credit that you can use as needed.
You can also use a personal loan to finance your home renovations. Personal loans usually have lower interest rates than credit cards. That said, you’ll still need to have a good credit score to qualify for a low-interest personal loan. If you don’t want to tap lending options, consider selling your life insurance or talking to an agent for a chance of getting the cash value of your premiums.
If you’re a veteran, you can also take out a VA loan to finance your home renovations. VA loans are available to eligible veterans and active-duty military members. These loans usually come with low interest rates and flexible terms.
Finally, you can use a credit card to finance your home renovations. This is usually not the best option since credit cards have high interest rates. But if you can pay off your credit card balance in full and avoid interest charges, then this might be a good option for you.
As you can see, home loan refinancing offers several benefits. It can help you switch to a fixed interest rate, eliminate private mortgage insurance, and change your loan term. But before you refinance your home loan, make sure you understand the process and the different types of loan refinancing.
If you’re not sure whether refinancing is right for you, talk to a financial advisor. They can help you understand your options and make the best decision for your situation.
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