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3 Common Reasons for Refinancing a Mortgage

by Brandon Cornett

Why should you refinance your mortgage loan? First of all, that's a decision you'll have to make on your own. This website neither encourages or discourages you from refinancing -- we simply seek to educate you on the process.

So let's look at things hypothetically. Why do homeowners in general refinance their mortgage loans? For many reasons, actually. But most of the reasons are in some way associated with the "big three" listed below.

1. To Lower the Interest Rate

The interest rate on a mortgage loan is the fee charged for borrowing money. The interest rate is partly what determines your monthly mortgage, so it's easy to see why homeowners would want a lower interest rate. This is one of the most common reasons for a mortgage refinance -- to obtain a lower interest rate.

For example, if your credit situation has improved from the time you first obtained your mortgage loan, you could likely qualify for a lower interest rate. This in turn would mean less of a mortgage payment each month, obviously a good thing.

2. To Change the Mortgage Type

Another reason for a mortgage refinance is to switch from one type of mortgage to another. Most often, this means going from an adjustable rate mortgage (ARM) to a fixed rate mortgage loan.

ARM loans usually start off with a low interest rate for an initial fixed period of time, such as the first three years. But after that initial period the ARM will adjust to whatever the prevailing interest rate is at the time (hence the name "adjustable rate mortgage"). Often, this means a big increase in the size of the monthly mortgage payment. Many homeowners in this situation will refinance the loan at a fixed rate, thus avoiding future adjustments altogether.

3. To Cash In On Equity

Some homeowners want to liquidate the equity they have built up in their home. Perhaps they want to put the money toward their children's education, home improvements or the vacation of their dreams. In such cases, a cash-out refinance can be a good option.

With this mortgage refinancing option, you would receive a cash payout at the closing process. Most mortgage lenders require you to have at least 5% equity (ownership) built up in the property before they will offer a cash-out refinancing option.

Quick definition: Equity is the difference between the property's value and the amount you still owe on the mortgage. If a home is valued at $100,000 and the mortgage balance is $90,000, the equity is $10,000 (or 10% of the home's value).

Conclusion

These are the most common reasons for refinancing a home mortgage. While there are certainly some variations on this "theme," most people's refinancing motivations somehow relate to one of the reasons listed above.