What is mortgage refinancing?
Mortgage Refinancing is usually done by the homeowners where the homeowner replaces an existing mortgage with another mortgage. Such may, in most cases, mean altering one or several mortgage terms. This financial move will help homeowners improve their financial condition by getting better mortgage terms or interest rates, or enable them to take out some equity they have established in their homes. Refinancing could be the best way to save on repaying the mortgage, reduce the mortgage term, or access funds for other needs. But while making this decision, it is essential to be sure to know all the ins and outs of how it works, what kinds of refinancing are there, and what the pros and cons are.
How Does Mortgage Refinancing Work?
What happens in mortgage refinancing is that a lender pays off your old mortgage with a new mortgage. What this therefore means is that you are effective in taking a new loan from the start once again. The process is much like when you get your mortgage. In this case, you need to make an application, allow credit investigations for purposes of establishing your creditworthiness, and then show proof of income along with your identification. Normally, the interest rate, term length, and sometimes the balance on the new mortgage are different from the interest rate and term length of your original loan.
Refinancing can have multiple steps, such as a home appraisal to know the real value of your current property. After the approval, you become liable to pay the new mortgage, replacing the old one. The new mortgage may also include the consolidation of other debts, as per your needs.
Types of Mortgage Refinancing
There are two major types of mortgage refinancing: rate and term refinancing and cash-out refinancing.
Rate and Term Refinancing
It is the most common form of refinancing. It includes simple modifications in the interest rate, mortgage term, or even both, with no changes in the amount borrowed under the initial loan. For example, you might refinance a 30-year mortgage down to a lower rate or transform it into a 15-year mortgage to pay off the debt more quickly. Rate-and-term refinancing is mostly done to reduce the cost of borrowing.
Cash-Out Refinancing
This is a refinancing through which the borrower may refinance for more than his or her outstanding mortgage loan balance and get the difference in cash. It offers a way to borrow money based on the equity you have in your home. For example, if a person’s home is worth $400,000 and he/she owes $250,000, he/she may refinance for $320,000 and receive $70,000 in cash. This cash can be used for various purposes, like home improvements, paying off high-interest debt, or funding large expenses. However, it also increases your mortgage balance and could extend the repayment period.
Advantages and Disadvantages of Mortgage Refinancing
By refinancing your mortgage, benefits can be accrued, but they must be weighed against the costs and risks.
Advantages
Low-Interest Rates
You can refinance with lower rates on interest, which reduces both your monthly payment amount and the total amount of interest to be paid throughout the mortgage term.
Shorter Mortgage Term
You can obtain a shorter term on the mortgage, and therefore pay the house off faster, by paying less on interest.
Cash-Out Refinancing
You can take out a rather substantial amount of funds in the form of one lump sum for major expenses.
Debt Consolidation
This is the opportunity to pay all other debts collectively with one monthly payment, mainly at a lower interest rate.
Cons
Closing Cost
Refinancing comes at a cost, at times very high. These costs will have to be factored into check against any potential savings.
Extended Loan Term
If you extend your mortgage, with time, you could end up paying more in interest, even if the monthly payment is lower.
Risk of Foreclosure
Those new mortgage payments, especially in the wake of a cash-out refinance, could be overwhelming, not to mention what might happen if you fall behind and the bank forecloses.
Impact on Credit Score
Since a hard inquiry is involved when you look to refinance, this means that your credit score will be slightly lower.
Should You Refinance a Mortgage ?
Any decision about whether to refinance a mortgage should be guided by one’s financial goals. Even further, things like locking in a much lower interest rate, getting you out of debt faster, having access to your equity for important things you need to do, and making sure you’re not stuck in a product beyond its time could all appear quite commonsensical. But you must account for the closing costs, potential impact on credit, and long-term financial implications.
But before you even go to step forward with refinancing, try calculating your break-even point, which is the exact point in time when your savings from the refinancing transaction will pay for the costs you incurred by refinancing. As long as you will stay in your house at least as long as your break-even point, then refinance. You can also talk to a financial advisor to help ensure that refinancing fits within your broader financial planning.
Conclusion
Mortgage refinancing will yield a huge financial benefit, whether it comes from just getting a better interest rate and lower monthly payments or cashing out some of your home equity for life needs. However, it is important in the decision-making process to consider the long-term potential benefits that refinancing may provide. Understand the type of refinancing and then weigh off the cost of refinancing against the benefits to be able to decide a course of action that will suit your economic future. Refinancing can help, sure, but like anything related to finances, it should be done in a planned and thoughtful manner.