Refinance Checklist: What Are Your Goals? (#1)

People come to mortgage refinancing from various places. Some want to lower their payment. Some what to shorten their term and thus own the home outright sooner. Others want to leverage home equity by cashing out.

A few years ago, homeowners who had been biding their time waiting for interest rates to drop so they could refinance their mortgage couldn't have expected rates to fall as low as they did in 2020. People everywhere seized the opportunity to lower their house payment. Demand grew so high that it triggered the Fed to institute a fee to cool the market and ensure a profit for banks (the fee has since expired).

During the two years of the pandemic, about 14 million homeowners refinanced their mortgage, according to New York Fed economists. Of course, rates have climbed since then, but plenty of people look into home loan refinancing even during periods of higher rates.

So that you can prepare yourself for the mortgage refinance experience, we thought we'd put together a checklist. The list grew so large that we're breaking it up into three segments. The first segment is your goals.

First, What Are Your Goals?

Taking advantage of record-low interest rates is certainly a key driver of demand in refinancing, but it isn't the only reason people refinance their home. Some hope to shorten the term of their loan so they will own the home sooner. Others want to fund home projects and thus build (or at least preserve) their equity. Still others want to lower their payment so they balance the household budget in the face of a rising cost of living.

"I want to lower my payment."

In the example we bring you here, a drop of just 1% in a 30-year mortgage can save the homeowner $163 every month and a whopping $58,522 in total interest paid. Look at this comparison of a $250,000 loan balance for 30 years at rates that are 1% different.

For the purposes of this comparison, we've left out property taxes, homeowner's insurance to cover yourself, and any mortgage insurance (PMI) you might also be required to pay to cover the lender's risk. We wanted to show you the naked overall savings you can get when the interest rate drops just 1%, which, as you can see, are substantial.

"I want to shorten the loan term."

The most popular mortgage in America is the 30-year fixed-rate, therefore most buyers face a long road of debt when they sign on. Going back to the starting point by refinancing another 30-year loan isn't appealing to many people. Some use refinancing as the opportunity to shorten their term whether or not their monthly payment changes much.

When you've already paid six or seven years on a mortgage (in other words, you have 23-24 years left), refinancing at a lower interest rate but only for 20 years can save you a lot of money. Your monthly payments might not change much, but you'll own the home years sooner than you initially expected and, come that day, will have paid a lot less interest.

It's great when a refinance brings you years closer to full homeownership. Just ask your lender to amortize your refinance loan for 25, 23, 20, or some other number of years. They will adjust your payments accordingly.

"I want to get cash out of the house to make repairs and improvements."

Since a refinance replaces an existing home loan with another, there's an opportunity to increase your loan balance and take the difference in cash. For example, if you owe $150,000 on your home, you could swap that loan for a new one at $175,000 and "cash out" $25,000.

"Certain home improvement projects can pay for themselves in equity and are therefore a great use of a cash-out refinance."

Lenders are happy to go along with a cash-out refi when the home's value has appreciated. Your home is worth more now, so even though you are increasing your debt, the ratio debt-to-value stays about the same. Also, since you've already made years of payments, you own more of the home now (equity) and are a more attractive, dependable borrower in the eyes of the bank.

Speaking of equity, a great use of cash-out refi money is to maintain the property. Use the funds for a new roof, say, or to reseal the driveway. Preserving your home's value with regular maintenance doesn't just make it a more comfortable place to live; it preserves your investment.

Certain home improvement projects can pay for themselves in equity and are therefore a great use of a cash-out refinance. People dream of posh swimming pools and gourmet kitchens, but the most financially rewarding project turns out to be attic insulation, according to a survey by Remodeling magazine, which Realtor.com wrote about. For every $100 spent on attic insulation, you can expect to recoup $116.90 when you sell the home.

Next Up: Closing Costs and Other Financial Concerns

Keep in mind that refinancing involves closing costs. It literally costs money to save money. However, some closing costs are negotiable. The need to pay closing costs is why some refinance plans don't make financial sense in the end. That will be the next topic in our refinance checklist, so please stay tuned.