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.
