The Basics of Refinancing Your Mortgage

Oct 23, 2017, 20:39 PM

The terms of an existing mortgage can become unmanageable for borrowers for a number of reasons. When this occurs, they may want to seriously consider other options, such as refinancing. The refinancing of a mortgage is a rather convenient option for those looking to restructure their financial situation.

Every year there are a significant number of applications to refinance mortgages. The reason behind this is that many people tend to adjust their debt-payment strategies based on their current circumstances.

Refinancing refers to the attainment of a new loan to take the place of an older one. Refinancing is categorized as “rate and term” or “cash-out.”

Rate and Term Refinancing

Rate and term refinancing refers to paying off a previous loan and adopting a new one with specific conditions. It proves beneficial when the interest rate declines or the period for payment is reduced.

Cash-out Refinancing

Cash-out refinancing provides borrowers with a cash payment preceded by all mortgage-related costs. A person is free to use the money in any way they want.

There are a number of reasons people opt for a refinance, some of which are listed below:

A Lower Interest Rate

This is one of the main reasons people tend to refinance. A suitably reduced interest rate may allow a person to save a significant amount of money along with the reduction in monthly installments. Although it is not so easy to find a mortgage package to meet one’s exact preferences, refinancing may still reduce payments considerably.

The refinancing of a mortgage is accompanied with an upfront closing cost because it is a new loan a person takes out to replace an older one.

A Shorter Time Frame

Some people plan to get rid of their loan in a shorter time frame than the period they previously selected. Refinancing provides an option to do so conveniently. This is preferred by debtors when:

  • Interest rates drop
  • There is an improvement in the debtor’s financial condition

The immediate consequence is the increase in the monthly payback, but refinancing to switch to a shorter period proves to be beneficial in the long run. Monthly payments can be roughly estimated, but a direct consultation of a creditor can give accurate figures before the commencement of mortgage refinancing.

Fixed Rate Verses Adjustable Rate Mortgages

Trading a fixed mortgage for an adjustable mortgage, or vice versa, can provide a way out of an unmanageable situation. If someone intends to adjust monthly payments to a budget, then it is preferable to shift from the Adjustable-Rate Mortgage (ARM) to a fixed-rate mortgage. Fixed-rate mortgages can provide peace of mind by allowing borrowers to avoid unexpected shifts in interest rates.

On the other hand, if someone is determined to pay off their debt quickly while interest rates are low, then a switch from a fixed-rate mortgage to an ARM can be a worthwhile decision. A change in the interest rate is a suitable opportunity for switching between fixed and adjustable mortgages.

A Cash-out

A cash-out refinancing is preferred by mortgagors in a few situations. For instance:

  • A person wants to get into an investment beyond his financial resources, or the resources available are proving to be more expensive than the rate obtained when refinancing.
  • It is necessary if a person wants to pay off excessive debt or to save money for any other dealings in the future.

One needs to have sufficient equity (the difference between the value of real estate and payable debt) to get a cash-out.

The Bottom Line

The purpose of mortgage refinancing is to ease the burden of debts, but if the decision is not made carefully, there will be no improvement in the existing situation. Therefore, it is highly recommended to find all the information at one’s disposal to come up with the most appropriate plan for mortgage refinancing.

Mortgage calculators are available for an accurate estimate of the amount a person might save when refinancing. Also, doing detailed research of loan policies can be helpful. A mortgage-financing decision, if made wisely, can accelerate the process of eliminating debt, and can provide financial peace of mind.

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