What is Mortgage Refinancing?
Refinancing is getting a new mortgage and using some or all of the proceeds to pay off your current mortgage. This often involves several of the processes and attendant expenses that were required when the original mortgage was obtained.
What are the Reasons for Refinancing?
Lower the Monthly Payment. Since you got your original mortgage, if the interest rate has gone down, your credit has improved, or your house has appreciated, then you could refinance your mortgage and reduce your monthly mortgage payment. This is the primary reason people refinance.
Switch Mortgage Type. You may want to switch from a variable to a fixed interest rate, or vice versa. Some borrowers may prefer a fixed-rate loan, but for reasons of qualifying or maintaining a cap on the monthly payment, opt to initially go with an adjustable-rate loan. Or you have have a balloon/reset mortgage, and you need to pay the mortgage in full at the end of the 5- or 7- year term, or start the process to reset your mortgage to a fixed rate, or refinance with a new mortgage.
Reduce the Term of the Mortgage. With a drop in interest rates, you may want to refinance to shorten the term of your loan while leaving the mortgage payment the same. This would translate to a less interest paid over the life of the loan since the money is borrowed for a shorter period of time.
Tap your Home's Equity. Instead of getting a home equity line of credit, you may refinance for an amount larger than your current balance. The portion that is left after paying off the original mortgage is available for investments, your child's education, debt consolidation, or other uses.
Should you Refinance?
The answer depends on your financial situation. There are several points to consider:
Do you have the funds to pay the up-front costs and fees of refinancing?
Refinancing your mortgage may require you to pay substantial 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 up-front costs by including them in the new mortgage.
How long will it take to recover the costs of refinancing?
The rule of thumb is that refinancing costs are recovered within two to three years. If you plan to sell your house or pay off your loan soon, you may not be able to recover your costs... this of course depends on the magnitude of costs and savings (in mortgage payments). There are other factors, too, like tax savings, etc.
Do you have significant debt at a high interest rate?
If you have credit card or other debts with interest rates significantly higher than the mortgage rates, it makes sense for you to refinance and cash out to pay off the debts with high interest rate.
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