A Guide to Refinancing Your Mortgage
You’re probably not going to refinance the mortgage on your house because you suddenly developed an insatiable urge to generate enormous loan fees for your friendly neighborhood lending institution. Here are three far more sensible reasons to refinance your mortgage:
- To cut costs: “A penny saved is a penny earned,” is every bit as true today as it was in Ben Franklin’s time, but why stop with a few lousy pennies? Think big. Lowering your monthly loan payment by replacing your present mortgage with a new one that offers a lower interest rate could save you tens of thousands of dollars over your new loan’s term.
- To restructure your financing: Slashing your monthly mortgage payment isn’t the only reason to refinance. In fact, you may need to refinance even if the new loan won’t save you one red cent. For instance, suppose you have a short-term balloon loan coming due soon that you must replace with long-term financing. Or maybe you want to trade in that volatile adjustable-rate mortgage (ARM) used to finance your home purchase for a more pedestrian (or predictable) fixed-rate loan so you can hit the sack each night without worrying yourself sick about the possibility of your loan’s interest rate skyrocketing.
- To pull cash out: If you’ve owned your home a long time, you’ve probably built up quite a bit of equity in it, thanks to the combined effect of paying down a small percentage of your loan’s outstanding balance every month through an amortizing loan and property appreciation. Instead of simply replacing the old mortgage with a new one of the same amount, some folks pull out additional cash, which they use for such purposes as starting a new business, helping pay for the kids’ college expenses, or planning that dream trip to Antarctica to see male penguins dutifully play Mr. Mom. You could probably come up with a couple of more ways to use some extra money if you really put your mind to it.
Refinancing a mortgage isn’t like ordering dinner in a Chinese restaurant where you select one item from column A and one from column B. What the heck. It’s your refi. You can do whatever you want. If you plan carefully, you may be able to accomplish all three objectives when you refinance.
Is refinancing a mortgage a good idea?
At times it may actually be a more prudent strategy to not refinance because there can be advantages to keeping the existing loan and seeking additional sources of funds in a different manner.
If you’ve had your loan for several years, remember that with all loans, you pay more interest in the beginning of the loan and more principal later in the loan. Ask yourself this hypothetical question: If your loan had only one year left on it (12 payments), but it carried a 10 percent interest rate and a monthly payment of $1,000, would you start a new 30-year loan (360 payments) at 5 percent with a $65 payment? Of course not! That’s why the age of your current loan matters when considering refinancing.
One smart idea is to look at the new monthly payments (principal + interest only) for the refinance based on the time period remaining on your current loan. For example, if your current loan has 12 years left on it (144 payments), then analyze the prospective refinance with payments over 12 years, too.
Does refinancing the loan still make sense? Even if the refinancing does not make sense over time, you may still go with the refinance if you really need the new lower monthly payments to survive your current financial situation. You’ll be helping yourself in the short term (with the lower payments), but you’ll be hurting yourself long term (by adding many years to the life of your loan), but sometimes this is the only solution.
How does refinancing a mortgage work?
The sole distinction between a purchase loan and a refinance mortgage is whether a change of property ownership occurs during the financial transaction. When you purchased your dream home, ownership of the house transferred from the seller to you. On the other hand, no change of ownership occurs when you subsequently opt to replace your existing mortgage with a new one.
Essentially, you will undergo the same process for a refinancing a mortgage as you do when applying for a mortgage for a home purchase.