Home Refinancing Basics
In recent years, Americans seeking to take advantage of low interest rates have lined up to refinance their mortgages. In fact, refinancing hit an all-time high in 2003, and remained high in both 2004 and 2005, according to the Mortgage Bankers Association of America.
But while it’s true that refinancing has the potential to help you reduce the costs associated with borrowing money to own a home, it is not necessarily a strategy that makes sense for every individual in every situation. So before you make a commitment to refinance your mortgage, its important to do your homework and determine whether such a move is the right one for you.
What is refinancing?
Refinancing replaces your current mortgage with a new loan that has a more favorable interest rate and terms that you can afford to manage. The new loan is secured on the same property as your current loan. We know mortages is The new loan funds are used to pay down the current mortgage while any remaining money can be used to your best advantage.
Example: Mr. X and Mr. Y both took out a mortgage loan worth $400,000. After 4 years, both of them paid off $200,000. Mr. X then took out another home loan worth $200,000 in order to repay the existing loan balance.
On the other hand, Mr. Y took out another mortgage worth $300,000 in order to repay the unpaid loan balance which is $200,000. Mr. Y could use the remaining balance in order to fulfill other financial obligations.
The first scenario is a simple refinance while the second is that of a “cash-out refinance”.
5 Reasons why you should refinance
If you’re thinking of refinancing your house, check out these 6 reasons why a mortgage refinance might be right for you.
* You want to save more:
Your monthly payments will be reduced if you get a lower interest rate or when the term of the loan is extended. However, with an extended term, you will be paying more in interest during the life of the loan.
* You want to pay down your mortgage quickly:
You can shorten the length of your mortgage by reducing the term of the loan. Your Monthly payments will go up, but you will be able to save more in interest payments. Moreover, you’ll be debt free sooner.
* You need extra cash to pay off credit cards:
If you have enough equity in your home, you can refinance and borrow more than the current loan balance. With the extra money, you can pay off high interest debts such as credit card balances or installment loans. This refinance loan may be tax deductible under certain conditions.
* You wish to consolidate 2 loans into one:
If there’s enough equity (due to high appreciation), you can consolidate a 1st and 2nd mortgage into a single mortgage. The monthly payment on the new loan might be lower than the combined payments on the first loan and the second mortgage.
* You want to convert an Adjustable Rate Mortgage (ARM) into a Fixed Rate Mortgage (FRM):
A FRM prevents the lender from increasing your monthly interest payments over the life of the loan, unlike with an ARM. This means your monthly payments will remain the same.
Remember — All Mortgages Are Not Created Equal
Don’t make the mistake of choosing a mortgage based only on its stated annual percentage rate (APR), because there are a variety of other important variables to consider, such as:
The term of the mortgage — This describes the amount of time it will take you to pay off the loan’s principal and interest. Although short-term mortgages typically offer lower interest rates than long-term mortgages, they usually involve higher monthly payments. On the other hand, they can result in significantly reduced interest costs over time.
The variability of the interest rate — There are two basic types of mortgages: those with “fixed” (i.e., unchanging) interest rates and those with variable rates, which can change after a predetermined amount of time has passed, such as one year or five years. While an adjustable-rate mortgage (ARM) usually offers a lower introductory rate than a fixed-rate mortgage with a comparable term, the ARM’s rate could jump in the future if interest rates rise. If you plan to stay in your home for a long time, it may make sense to opt for the predictability and security of a fixed rate, whereas an ARM might make sense if you plan to sell before its rate is allowed to go up. Also keep in mind that interest rates hovered near historical lows in recent years and are more likely to increase than decrease over time.
Points — Points (also known as “origination fees” or “discount fees”) are fees that you pay to a lender or broker when you close the deal. While a “no-cost” or “zero points” mortgage does not carry this up-front cost, it could prove to be more expensive if the lender charges a higher interest rate instead. So you’ll need to determine whether the savings from a lower rate justify the added costs of paying points. (One point is equal to one percent of the loan’s value.)