Mortgage Refinancing: Factors & Benefits: Understanding the process of refinancing can be quite dizzying. Homeowners who are considering re-financing might initially be overwhelmed by the number of options available to them.
However, after taking some time to educate themselves about the process, they will likely find the process is not nearly as daunting as they had imagined.
This article will discuss some of the benefits of mortgage refinancing, options available to those interested in refinancing as well as some of the important factors to consider in order to determine whether or not refinancing is worthwhile.
Benefits of Mortgage Refinancing
There are a number of benefits which may be associated with refinancing a home. While there are some situations where re-financing is not the right decision, there are a host of benefits which can be gained from refinancing under favorable conditions.
Some of these benefits include lower monthly payments, debt consolidation and the ability to utilize the existing equity in the home. Homeowners who are considering refinancing should consider each of these options with their current financial situation to determine whether or not they wish to refinance their home.
1. Lower Monthly Payments
For many homeowners the possibility of lower monthly payments is a very appealing benefit of refinancing. Many homeowners live paycheck to paycheck and for these homeowners finding an opportunity to increase their savings can be a monumental feat.
Homeowners who are able to negotiate lower interest rates when they refinance their home will likely see the benefit of lower monthly mortgage payments resulting from the decision to refinance.
Each month homeowners submit a mortgage payment. This payment is typically used to repay a portion of the interest as well as a portion of the principle on the loan. Homeowners who are able to refinance their loan at a lower interest rate may see a decrease in the amount they are paying in both interest and principle.
This may be due to the lower interest rate as well as the lower remaining balance. When a home is refinanced, a second mortgage is taken out to repay the first mortgage. If the existing mortgage was already a few years old, it is likely the homeowner already had some equity and had paid off some of the previous principle balance.
This enables the homeowner to take out a smaller mortgage when they refinance their home because they are repaying a smaller debt than the original purchase price of the home.
2. Debt Consolidation
Some homeowners begin to investigate re-financing for the purpose of debt consolidation. This is especially true for homeowners who have high interest debts such as credit card debts.
A debt consolidation loan enables the homeowner to use the existing equity in their home as collateral to secure a low interest loan which is large enough to repay the existing balance on the home as well as a number of other debts such as credit card debt, car loans, student loans or any other debts the homeowner may have.
When re-financing is done of the purpose of debt consolidation there is not always an overall increase in savings. Those who are seeking to consolidate their debts are often struggling with their monthly payments and are seeking an option which makes it easier for the homeowner to manage their monthly bills.
Additionally, debt consolidation can also simplify the process of paying monthly bills. Homeowners who are apprehensive about participating in monthly bill pay programs may be overwhelmed by the amount of bills they have to pay each month.
Even if the value of these bills is not worrisome just the act of writing several checks each month and ensuring they are sent, on time, to the correct location can be overwhelming. For this reason, many homeowners often refinance their mortgage to minimize the amount of payments they are making each month.
3. Using the Existing Equity in the Home
Another popular reason for refinancing is to use the existing equity in the home. Homeowners who have a considerable amount of equity in their home may find they are able to cash out some of this equity for other purposes.
This may include making improvements to the home, starting a business, taking a dream vacation or pursuing a higher degree of education. The homeowner is not limited in how they can use the equity in their home and may refinance a home equity line of credit which can be used for any purpose imaginable.
A home equity line of credit is different from a loan because the funds are not disbursed all at once. Rather the funds are made available to the homeowner and the homeowner can withdraw these finds at anytime during the draw period.
Important Factors To Consider in Refinancing
1. Consider the Options
Homeowners have quite a few options available to them when they are considering the possibility of refinancing their home. The most significant decision is the type of loan they will choose.
Fixed rate mortgages and adjustable rate mortgages (ARMs) are the two main types of mortgages the homeowners will likely encounter. Additionally there are hybrid loan options available.
Fixed rate mortgage
As the name implies, a fixed rate mortgage is one in which the interest rate remains constant throughout the duration of the loan period. This is an especially favorable type of loan when the homeowner has credit which is sufficient enough to lock in a low interest rate.
Adjustable rate mortgage
ARMs are mortgages where the interest rate varies during the course of the loan period. The interest rate is usually tied to an index such as the prime index and is subject to rises and falls in accordance with this index. This is considered a riskier type of loan and is therefore often offered to homeowners who have less favorable credit scores.
Although ARMs are considered somewhat risky there is usually a certain degree of protection written into the loan agreement. This may come in the form of a clause which limits the amount the interest rate can increase, in terms of percentage points, over a fixed period of time.
This can protect the homeowner from sharp increases in the interest rates which would otherwise considerably raise the amount of their monthly payments.
Hybrid loans are mortgages which combine a fixed element with an adjustable element. An example of this type of loan is a situation where the lender may offer a fixed interest rate for the first five years of the loan and a variable interest rate for the remainder of the loan. Lenders typically offer a lower introductory interest rate for the fixed period to make the mortgage seem more enticing.
2. Consider the Closing Costs
The closing costs associated with refinancing should be carefully considered when deciding whether or not to refinance the home. This is significant because when homeowners refinance their home they are often subject to many of the same closing costs as when they originally purchased the home.
These costs may include, but are not limited to appraisal fees, application fees, loan origination fees and a host of other expenses. These costs can be quite significant. The closing costs will be significant when the homeowner considers the overall savings associated with refinancing.
3. Consider the Overall Savings
When deciding whether or not to refinance, the overall savings is one factor the homeowners should carefully consider. This is important because re-financing is typically not considered worthwhile unless it results in financial savings.
Although some homeowners refinance to lower monthly costs and are not concerned with the overall picture, most homeowners consider whether or not they will be saving money by refinancing.
The amount of money the homeowner will save when refinancing is largely dependent on the new interest rate in relation to the old interest rate. Other factors come into play such as the remaining balance of the existing loan as well as the amount of time the homeowner intends to stay in the home before selling the property.
It is important to note that the amount of money saved by negotiating a lower interest rate is not equal to the entire savings. The homeowner must determine the closing costs associated with refinancing and subtract this sum from the potential savings.
A negative number would indicate the new interest rate is not low enough to offset the closing costs. Conversely a positive number indicates an overall savings. With this information the homeowner can decide whether or not he wishes to refinance.