Introduction to Refinancing
Refinancing involves paying off your current mortgage and replacing it with a new mortgage. It often involves many of the same steps and expenses that were required when the original mortgage was obtained.
The most common reason to refinance is to lower your monthly mortgage payments, but there are other reasons to consider refinancing.
Reasons to Refinance
- Lower the Monthly Payment: If interest rates have dropped, refinancing may lower your mortgage payment. This is the primary reason people refinance.
- Reduce the Term (Length) of the Mortgage: A drop in interest rates may allow you to shorten the amount of time you pay the mortgage but leave the mortgage payment about the same.
- Reduce the Risk on an Adjustable Rate Mortgage (ARM): An ARM mortgage may have enabled you to afford your home but if the interest rate has increased significantly, evaluate a fixed rate alternative. The risk of further interest rate increases is then eliminated.
- Use the Home's Equity: As an alternative to a home equity loan, you may elect to refinance your home for an amount greater than the remaining balance of your mortgage. This is known as a "cash out" loan.
- Consolidate Debts: An owner with outstanding loans or credit card balances that have high interest rates can consolidate these loans into one new mortgage.
Should You Refinance?
To refinance or not depends on your own personal financial situation. There are many mortgage options available so make sure to carefully examine each option. Also, remember that the best option may be to do nothing at all.
Points to consider:
- Do I have the funds that refinancing may require to cover up-front costs and fees? Refinancing your mortgage may require you to pay a large amount of money to cover up-front costs and fees. If you do not have enough money to pay the up-front costs completely it may be possible to finance some of the costs by including them into the new mortgage.
- How long until I recover the costs of refinancing? The rule of thumb is the refinancing costs are recovered within 2-3 years. So, if you plan to sell the house or pay it off shortly, you may not want to refinance because you will not recover the costs. Obviously, this depends on the up-front costs and the savings with the new mortgage.
- Has my income increased substantially? If your income has increased substantially, you may be able to afford higher monthly payments. This may allow you to shorten the term of your mortgage. If the available interest rate is lower for the shorter term mortgage, refinancing is a good option. Otherwise, simply make larger principal payments against your current mortgage.
- Is the current loan an Adjustable Rate Mortgage (ARM)? If the current rates for a fixed rate mortgage are the same or slightly higher than your ARM, refinancing may make sense. If the fixed rate is lower than they are expected to be when your ARM converts to a fixed rate, it may make sense to refinance.
Obviously, much thought needs to go into the refinancing decision. Also, you should evaluate this decision regularly to account for changes both in your financial situation and the economy. Perhaps, the decision is not to refinance now, but a few years from now it may save you thousands of dollars.
