The most common reason for refinancing is to save money.
Saving money through refinancing can be achieved in two ways:
- By obtaining a lower interest rate that causes one's
monthly mortgage payment to be reduced.
- By reducing the term of the loan, thus saving money over
the life of the loan. For example, refinancing from a
30-year loan to a 15-year loan might result in higher
monthly payments, but the total of the payments made during
the life of the loan can be reduced significantly.
People also refinance to convert their adjustable loan to
a fixed loan. The main reason behind this type of refinance
is to obtain the stability and the security of a fixed loan.
Fixed loans are very popular when interest rates are low,
whereas adjustable loans tend to be more popular when rates are
higher. When rates are low, homeowners refinance to lock in low
rates. When rates are high, homeowners prefer adjustable loans
to obtain lower payments.
A third reason why homeowners refinance is to consolidate
debts and replace high-interest loans with a low-rate mortgage.
The loans being consolidated may include second mortgages,
credit lines, student loans, credit cards, etc. In many cases,
debt consolidation results in tax savings, since consumers loans
are not tax deductible, while a mortgage loan is tax deductible.
The answer to the question "Should I refinance?" is a complex
one, since every situation is different and no two homeowners
are in the exact same situation. Even the conventional wisdom of
refinancing only when you can save 2% on your mortgage is not
really true. If you are refinancing to save money on your
monthly payments, the following calculation is more appropriate
than the rule of 2%:
- Calculate the total cost of the refinance––example:
$2,000
- Calculate the monthly savings––example: $100/month
- Divide the result in 1 by the result in 2––in this case
2000/100 = 20 months. This shows the break-even time. If you
plan to live in the house for longer than this period of
time, it makes sense to refinance.
Sometimes, you do not have a choice––you are forced to
refinance. This happens when you have a loan with a balloon
provision, but with no conversion option. In this case it is
best to refinance a few months before the balloon comes due.
Whatever you choose to do, consulting with a seasoned
mortgage professional can often save you time and money. Make a
few phone calls, check out a few web sites, crunch on a few
calculators and spend some time to understand the options
available to you.
