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Refinancing mortgage loans - what you need to know about refinance loans

There are times when it makes sense to refinance your mortgage. It’s important to have a clear financial objective in mind so that you’re more able to choose the most appropriate loan. Ultimately, the decision is up to you to decide when it’s best for you to refinance, based on your individual financial situation. There are a host of reasons why you might want to refinance your current home loan, however most people refinance for the following reasons.

  1. To reduce their monthly mortgage loan payments
  2. To consolidate outstanding debt (such as combining a first and second mortgage)
  3. To tap built-up equity in your home

And some simply want to change their mortgage situation (i.e. moving to a more stable product such as going from an adjustable rate mortgage to a fixed rate mortgage.

Whichever reason fits your personal situation, there are certain basic rules you must follow to achieve your goal. Straying from some of these basics can end up costing you time and money.

When is the right time to Refinance?

The rule of thumb regarding mortgage refinancing is that you should not refinance until rates are such that you can get an interest rate at least 2% below the interest rate you currently have is not exactly accurate. For some people, as little as one-half of one percent can be enough to provide worthwhile savings if all other factors fall into place. The only way to determine whether refinancing your mortgage is for you is to analyze the time and the cost factors.

How long do you plan on holding this Mortgage Loan?

You might have a mortgage loan product that demands refinancing -- like a balloon mortgage. But if you don't have to refinance your mortgage, your time frame can be as long as you plan to stay in your current home. When determining your time factor, it's important to be realistic, since the time factor will determine if and when you begin to save money. Refinance loans can cost a considerable amount of money, so you'll want to be as certain as possible of your time frame.

Cash out Refinance Loan or Home Equity Loan

If freeing up cash is your goal, there's a way to do so, without refinancing: taking a home-equity loan. Home equity loans are an alternative, although they are not without their own drawbacks. Most Home Equity loans are of the adjustable-rate, revolving 'line of credit' type, (but most don't have per-adjustment interest rate caps, and some have lifetime caps of as much as 25%). There are fixed rate home equity loans available too, and they function much like any first or second mortgage does, but will cost you more than a line of credit.

Refinance from an Adjustable Rate Mortgage (ARM) to a Fixed-Rate

It’s important to consider what mortgage rates are doing. Are mortgage rates rising or falling? If you have an adjustable rate mortgage (ARM), it may adjust to a rate that’s higher than a fixed-rate mortgage. Now might be a good time to consider refinancing to a fixed-rate loan.

However, you must also consider the amount of time you plan on being in your home. If you’re only going to be in your home for a few more years, it may make sense not to refinance out of your ARM. If you’re going to be in your home longer than seven years, it might be a smart move to refinance to a fixed-rate mortgage.

Lower Your Monthly Mortgage Payment

A drop of just one half to three quarters of a percentage point in interest can lower your monthly payment. If you don’t refinance, you may be paying too much every month for your loan, and that’s never a good financial move. There are a few different ways you can lower your monthly mortgage payment.

First, you can simply refinance to a lower interest rate. A lower rate generally means a lower monthly payment.

Second, you can change the term of your mortgage. For instance, if you have a 15-year mortgage, you can lengthen the term to 30 years. Since the balance of your mortgage is spread out over a longer period of time, your payment is lower. However, if you have a 30-year mortgage and one of your financial goals is long-term savings, you may want to consider shortening your term to 20 or even 15 years. Your payment will be higher, but you will pay much less in interest over the life of the loan, saving you thousands of dollars in the long run.

The third way to lower your payment is to refinance to an interest-only loan. Basically, with an interest-only loan, the minimum amount you are required to pay is the amount of interest for a certain period of time, though you can pay as much principal as you like. But you get the flexibility to pay less if you need or want to divert your money elsewhere, such as contributing to your 401k or saving for your child’s college tuition.

Getting Cash from Your Home

The equity you have in your home can act like a savings account that you could access through a home equity loan or a cash-out refinance. This is usually done when you want to finance an important home improvement, pay for college or pay off high-interest credit card debt. Whatever your reason, this may be the right option for you.

Consolidating High-Interest Credit Card Debt

The difference between credit card debt and a mortgage can, financially speaking, mean thousands of dollars. Why? Because unlike your mortgage, the interest you pay on a credit card is not tax-deductible and you pay a higher rate than you would on your mortgage. Because of this, credit card debt is often referred to as “bad debt” whereas your mortgage is considered “good debt.” Using your home equity to pay off your high-interest credit card debt can save you money in the long run. Using your home equity, rather than your credit cards, to finance expensive purchases can also be a smart move. Be sure to consult your tax advisor. Trust us on this. Don’t deduct and just cross your fingers for good luck. Know what you are doing before you mess with your taxes!

Deciding on when to refinance your mortgage will depend on the circumstances of your situation: how long you’ll be in the home, what your financial goals are, whether interest rates are dropping, etc. It’s up to you to decide if it’s right for you.

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Updated: 3/23/23 @ 1:57 PM

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