Millions of Americans refinance their home mortgages each year. Refinancing a mortgage can help homeowners obtain a lower finance rate over the life of the loan, lowering their monthly mortgage payments. Mortgage refinance lenders are competing for the business of homeowners looking to refinance. A prudent homeowner can find the best mortgage refinance rates by comparing the services of multiple lenders. Before making the decision to refinance, there are several factors the borrower should consider.
If a homeowner finds himself having difficulty in paying a high monthly mortgage payment, it is possible to reduce the dollar amount of the monthly mortgage payments by refinancing with a longer term to pay back the loan. While this will accomplish the task of lowering monthly payments, it also adds to the time it takes to pay off the loan and will increase the total amount paid towards interest over the life of the loan.
Lower monthly payments are not the only good reason for refinancing. A mortgage can be refinanced to a shorter-term loan. Shorter-term mortgages generally have lower interest rates. The borrower can also save money by paying off the loan sooner than the term of the loan and reducing the interest costs of the mortgage even further. The interest rates on these types of loans are lower, but the monthly payments are usually higher because a greater percentage of the payment goes toward paying down the principal balance.
Cash-out refinancing is another reason some people want to refinance a home mortgage. With cash-out refinancing, the mortgage is for a greater amount than the dollar amount owed on the home. The homeowner can use the money for such things as a child’s college education, to pay off other loans, or to make home improvements. However, when homeowners refinance with the cash-out refinance option, they are reducing the amount of equity they have in the home. This could be bad if they have to sell the home because they will not get as much cash back from the sell.
When refinancing is a bad idea
For homeowners who have had their mortgage loans for several years, refinancing could be a bad idea. After several years of paying on a mortgage loan, the amount of the payment that is credited to the principal increases. By refinancing, the amortization process is started over. The monthly payments will go back to being applied mainly to the interest instead of the principal of the loan. Furthermore, a prepayment penalty could be applied to the existing mortgage when it is refinanced, which may outweigh the benefits of the refinance. People who are planning to move in the next few years may also not benefit from refinancing because the benefits of lower monthly payments may not exceed the cost to refinance.
To be eligible for refinancing, a homeowner must go through the qualification process, just as they did when purchasing a home. A refinance lender is going to look at the borrower’s credit score, debts, income and assets, property value, and the amount of money to be financed. Borrowers with good credit scores should not have any trouble qualifying to refinance their loans; However, if the homeowner has a lower credit score than when he took out the original mortgage, he may not qualify for mortgage refinancing.
What are the different refinancing options?
There are many refinancing options available to homeowners. The type of loan borrowers choose will depend on their individual circumstances and what they hope to achieve through refinancing their home. Several common types of refinance options include:
- Adjustable rate mortgages: Adjustable rate mortgages have a fixed rate for a pre-determined number of years into the loan. After this period is over, the rates can fluctuate either up or down. If borrowers are fairly certain rates will stay the same or drop, they may want to go with this refinance option.
- Fixed rate mortgages: Fixed rate mortgages offer the security of locking in an interest rate over the entire life of the loan. Home buyers are able to budget expenses with the certainty that their interest rate will not increase. For borrowers looking for long-term interest rate security, this is a good option.
- Balloon loans: Balloon loans are short-term loans typically financed for 7-10 years. The advantage is that interest rates are low. A disadvantage is that the loan becomes payable in full when the loan term is up.
- Home equity loans: Home equity loans offer homeowners an option of borrowing against the equity in their own home. Interest rates are fixed for the life of the loan. This option can provide cash needed for major purchases or other financial needs. The downside is that it reduces the owner’s equity in the home.
- Lines of credit: A line of credit allows the homeowner to tap into the equity of their home borrowing only when the need arises. Borrowers are only required to pay interest on the loan during the draw period, normally a period of 5-10 years. As with a home equity loan, a line of credit reduces the owner’s equity in the home.
A homeowner needs to take all these factors into consideration before making a final decision to refinance. If after considering all the facts, it is still unclear whether a mortgage refinance is the best option, a financial advisor and tax consultant can give valuable advice to determine if refinancing a mortgage is the way to go.