The most common reason for refinancing
is to save money. Saving money through refinancing can be
achieved in two ways:
- By obtaining a lower interest rate
that causes one's monthly mortgage payment to be reduced.
- By reducing the term of the loan,
thus saving money over the life of the loan. For example,
refinancing from a 30-year loan to a 15-year loan might result in
higher monthly payments, but the total of the payments made during
the life of the loan can be reduced significantly.
People also refinance to convert
their adjustable loan to a fixed loan. The main reason behind this
type of refinance is to obtain the stability and the security of a
fixed loan. Fixed loans are very popular when interest rates are low,
whereas adjustable loans tend to be more popular when rates are
higher. When rates are low, homeowners refinance to lock in low rates.
When rates are high, homeowners prefer adjustable loans to obtain
lower payments.
A third reason why homeowners refinance
is to consolidate debts and replace high-interest loans with a
low-rate mortgage. The loans being consolidated may include second
mortgages, credit lines, student loans, credit cards, etc. In many
cases, debt consolidation results in tax savings, since consumers
loans are not tax deductible, while a mortgage loan is tax deductible.
The answer to the question "Should
I refinance?" is a complex one, since every situation is
different and no two homeowners are in the exact same situation. Even
the conventional wisdom of refinancing only when you can save 2% on
your mortgage is not really true. If you are refinancing to save money
on your monthly payments, the following calculation is more
appropriate than the rule of 2%:
- Calculate the total cost of the
refinance––example: $2,000
- Calculate the monthly
savings––example: $100/month
- Divide the result in 1 by the result
in 2––in this case 2000/100 = 20 months. This shows the
break-even time. If you plan to live in the house for longer than
this period of time, it makes sense to refinance.
Sometimes, you do not have a
choice––you are forced to refinance. This happens when you have a
loan with a balloon provision, but with no conversion option. In this
case it is best to refinance a few months before the balloon comes
due.
Whatever you choose to do, consulting
with a seasoned mortgage professional can often save you time and
money. Make a few phone calls, check out a few web sites, crunch on a
few calculators and spend some time to understand the options
available to you.
