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Refinancing means, replacing an existing mortgage with a
new mortgage on the same property. This new mortgage pays
off the old mortgage and may carry different terms than the
old one. Refinancing usually involves additional paperwork
and extra costs.
Why Refinance?
There are various reasons why people refinance their existing
mortgage. The most common is to get a lower interest rate
on the loan, but others also refinance in order to convert
a fixed-rate loan to an adjustable-rate loan (or vice versa),
to stop paying private mortgage insurance (PMI), or to get
cash out of your home's equity.
Many homeowners are realizing that if they plan to sell their
home in a few years they can save money by switching to an
adjustable-rate mortgage (ARM). ARMs are usually about two
percentage points less than fixed rate loans.
If you originally borrowed more than 80% of the home's value,
you were probably required to pay for PMI as well. If you've
been paying on your home for several years, or its value has
increased since you bought it, you may be able to stop paying
for PMI.
People also go in for refinancing to pay for big expenses
like tuition or home improvement.
Is Refinancing Right For Me?
When rates are low, homeowners look at current interest rates
and compare them to the terms of their existing mortgage.
If the current rates are much lower, homeowners usually go
in for refinance in order to take advantage of the lower rates.
Refinancing will not necessarily benefit homeowners if they
have a second mortgage, a lot of debt, or bad credit.
First, consider how much equity you have in your home. If
you financed your home for close to its full value only a
few years ago, you probably don't have enough equity to make
it worth refinancing, since it involves extra closing costs.
Second, consider your credit rating and your debt to income
ratio. If your credit rating is not good or if you have a
lot of debt, the rates offered by the lenders will either
be higher than your current rate, or not worth the costs of
refinancing.
There are two other situations where refinancing is not worth
going for. The first is if you refinance in order to combine
a first mortgage and a home equity loan, or if you receive
enough cash back to cause you to finance more than 80% again,
which would require you to carry PMI. This additional expense
could cancel out the benefits of refinancing.
The other scenario is if you've been paying off the loan for
a long time and have almost paid it off. Refinancing at that
point would mean restarting the loan and that is not worth
it. But you can negotiate with the lender to set new terms
for the same amount of time you had left on your old loan.
To decide if it's worth refinancing, find out the costs for
refinancing, including points, transaction fees, and closing
costs, and your new payment amount.
Compare that with your current payment and figure out how
long it will take you to recover the costs as well as how
much longer you plan to stay in the house.
It's generally not cost effective to refinance if you plan
to stay in your home for a short period.
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