Advantages of Refinancing Your Mortgage

When refinancing a mortgage, the borrower uses money from a new mortgage to pay off the debt of an existing one. If done correctly and at the right time, refinancing is an excellent way of reducing your total debt load and can provide you with significant monthly savings on your mortgage payments.

It is important to note that there are some costs associated with the refinancing process. Refinancing typically costs 3-6% of the borrower’s current outstanding mortgage principal. This is mostly attributed to the fact that taking out a new mortgage involves paying closing costs, and in some situations the borrower may be responsible for a prepayment penalty on their existing mortgage. In the long run, however, refinancing at the right time for the right reasons will save you more than the cost of getting a second mortgage.

Benefits of Refinancing

For most homeowners, the goal of refinancing is to obtain a mortgage with a lower interest rate and save money on future repayments. If you purchase your home at a time when interest rates are high, refinancing after rates drop can save you a large amount of money. However, as noted above, it is important for homeowners to consider the costs attributed to the process when deciding whether or not to refinance.

Refinancing can save you thousands of dollars in interest if your second mortgage has a shorter term than the first, even if you do not lock in a lower interest rate on the second mortgage. If, for example, you are six years into a 30 year mortgage, and find that you are able to afford higher mortgage payments, you might want to consider switching to a 20, 15 or 10 year mortgage. This will not only translate into significant savings in terms of the amount of interest you pay, but will also allow you to build up equity in your home more quickly.

Another situation where you might look to refinance is if you wanted to exchange some of the equity in your home for cash. However, doing so would mean that you would be borrowing more money than you currently owe, thus extending the terms of your mortgage. In general, this is only a good idea when the homeowner plans to use that received cash to add value to their home, either through remodeling or building onto the property. Refinancing is not a good idea when one plans to use the money to pay off credit card debt, or buy assets that depreciate quickly, such as a new car.

When is Refinancing a Good Idea?

In some situations, refinancing is unlikely to help you pay off your mortgage faster or reduce your monthly mortgage repayments. For example, refinancing is almost never a good idea when your credit rating is worse than it was when you acquired your original mortgage. In this case, your lower credit score will usually mean that you cannot get an interest rate that is favorable enough to lower the cost of the new mortgage.

In general, refinancing is a good idea when:

* You will be living in your home long enough for the costs of refinancing to be recouped by the savings you make on your new mortgage payments. In most cases this will take five to seven years.
* Your new loan is less than 80% of the current value of your home.
* Your new loan balance does not exceed the total amount owing on your existing mortgage.
* When mortgage rates are low
* Your credit rating is equal to or higher than it was when you originally took out your mortgage.

If you have an adjustable rate mortgage (ARM), refinancing may be a good option even in situations where some of the above points do not apply. For example, if you financed your home through an ARM when interest rates were low, and rates are now set to rise, a fixed rate mortgage may be a good idea. Another good reason to refinance out of an ARM is in a situation where you originally bought your home with the intention of moving within a few years, but have since decided to stay for the long term. Sticking with an adjustable rate mortgage is risky in the long run, and it is often more prudent to switch to a fixed rate mortgage if you plan to keep the property.

The benefits of refinancing also depend on the age of your mortgage. If you are twenty years into a 30 year mortgage, refinancing should be approached with caution. Taking out a new mortgage this late in the life of the original will only reduce the equity you have in your home if you borrow more than your current outstanding balance. If you have already paid off more than half your mortgage balance, refinancing will not usually save you money, even if you do lock in a lower interest rate. This is because conventional mortgage repayments are front loaded with interest, and at this stage your repayments are mostly going towards the principal.

- Edwin, CashTheChecks.com