Refinance to Build Equity

Refinancing a mortgage essentially means paying off an existing loan and replacing it with a new one. Homeowners may decide to consider refinancing for a number of reasons.  Potential reasons include,but certainly aren't limited to: the chance to lock in to a lower interest rate; an opportunity to shorten the term of the mortgage; wanting to convert from an ARM to a fixed-rate mortgage (or vice versa); tapping into equity to finance another purchase; or to consolidate debt.

All of the above options have potential benefits as well as risks. But, if you’re looking into refinancing as a way of building equity or paying off your home more quickly, you’ll want to focus primarily on how refinancing can: 1) help secure a lower interest rate; 2) shorten your loan’s terms; and 3) convert between adjustable rate and fixed rate mortgages. It’s in these areas where refinancing can make a big difference in your effort to build equity in your home.

One of the best reasons to refinance is to lower the interest rate on a loan you already have. The rule of thumb has usually been said to be that it was worth the money to refinance if you could reduce your interest rate by at least 2%. Today, however, many lenders say 1% savings is enough incentive to refinance.  Decreasing your interest rate not only helps you save money, but increases the rate at which you build equity in your home, and can decrease the size of your monthly payment(s).

When interest rates fall, homeowners often have the opportunity to refinance an existing loan for another that, without much change in the monthly payment, has a shorter term. For that 30-year fixed-rate mortgage on a $100,000 home, refinancing from 9% to $5.5% cuts the term in half to 15 years, with only a slight change in the monthly payment from $804.62 to $817.08. If you’re looking to build equity, this would certainly be a good deal.

While adjustable rate mortgages start out offering lower rates than fixed-rate mortgages, periodic adjustments often result in rate increases that are higher than the rate available with a fixed-rate mortgage. When this occurs, converting to a fixed-rate mortgage results in a lower interest rate and gets rid of any fear of future interest rate hikes.  On the other hand, converting from a fixed-rate loan to an adjustable rate mortgage can also be a sound financial strategy, especially if interest rates are falling. If rates continue to fall, the periodic rate adjustments on an adjustable rate mortgage result in decreasing rates and smaller monthly mortgage payments, eliminating the need to refinance every time rates drop.