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Glossary:
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Should I refinance? |
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.
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