Mortgage: Everything you need to know....and more!

Why Should I Refinance My Home?

You may want to refinance to take advantage of lower interest rates or to change the type of mortgage you have. It’s important to be aware of your long-term financial goals when looking at whether or not to refinance. Here are three good reasons to refinance your home!

1. Pay Less Each Month

Refinancing is a good way to lower your monthly mortgage payment. You can refinance to a lower interest rate. Or, you can change the terms of your mortgage. You can go from a 15-year mortgage to a 30-year mortgage. Finally, you can refinance to an interest-only loan. This means that you are required to pay an amount of interest for a certain period of time and can pay as much principal as you want. This can free up your money to make other investments.

2. Change the type of mortgage you have

If you have an adjustable rate mortgage (ARM) you may want to refinance to a fixed rate mortgage, especially if interest rates are going up and you plan on staying in your home for many more years. You might want to refinance from a fixed rate mortgage to an adjustable-rate mortgage if you are not going to stay in your home for very long since ARM’s start out with lower rates and lower monthly mortgage payments.

3. You need cash

If you need to pay for college or pay off high-interest credit card debt you may want to refinance to get some extra cash. When you pay interest on your mortgage it is tax-deductible. Interest on credit cards is not. Credit cards usually have higher interest rates than mortgages. It might be a good move to use your home equity to pay off your high-interest credit cards. Mortgage is “good debt” and credit cards are “bad debt.” It simply makes sense to get rid of any bad debt. However, you should consult a tax advisor or financial professional to help you with this.

 

Refinancing

Refinancing refers to the replacement of an existing debt obligation with a debt obligation bearing different terms. The most common consumer refinancing is for a home mortgage.

If the replacement of debt occurs under financial distress, it is instead referred to as debt restructuring.

Advantages

Refinancing may be undertaken to reduce interest rate/interest costs (by refinancing at a lower rate), to extend the repayment time, to pay off other debt(s), to reduce one's periodic payment obligations (sometimes by taking a longer-term loan), to reduce or alter risk (such as by refinancing from a variable-rate to a fixed-rate loan), and/or to raise cash for investment, consumption, or the payment of a dividend.

In essence, refinancing can alter the monthly payments owed on the loan either by changing the loan's interest rate, or by altering the term to maturity of the loan. More favourable lending conditions may reduce overall borrowing costs. Refinancing is used in most cases to improve overall cash flow.

Another use of refinancing is to reduce the risk associated with an existing loan. Interest rates on adjustable-rate loans and mortgages shift up and down based on the movements of the various indices used to calculate them. By refinancing an adjustable-rate mortgage into a fixed-rate one, the risk of interest rates increasing dramatically is removed, thus ensuring a steady interest rate over time. This flexibility comes at a price as lenders typically charge a risk premium for fixed rate loans.

In the context of personal (as opposed to corporate) finance, refinancing a loan or a series of debts can assist in paying off high-interest debt such as credit card debt, with lower-interest debt such as that of a fixed-rate home mortgage. This can allow a lender to reduce borrowing costs by more closely aligning the cost of borrowing with the general creditworthiness and collateral security available from the borrower. For home mortgages, in the United States, there may be certain tax advantages available with refinancing, particularly if one does not pay Alternative Minimum Tax.

As a general rule, refinancing home mortgages truly only works if the interest rates are low, and if it saves lots of money which would have else been used to pay off the monthly recurring bills on the current loan. In addition, by refinancing home mortgages one is able to get better credit because he will be able to make your payments quicker.

 

Risks

Most fixed-term debt contains penalty clauses (known as "call provisions") that are triggered by an early payment of the loan, either in its entirety or a specified portion. In addition, there are also closing and transaction fees typically associated with refinancing debt. In some cases, these fees may outweigh any savings generated through refinancing the loan itself. Typically, one only rationally considers refinancing if the potential for a substantial cost savings exists, or if there is a need to extend the loan due to weak cash flow or other non-recurring commitments.

In addition, some refinanced loans, while having lower initial payments, may result in larger total interest costs over the life of the loan, or expose the borrower to greater risks than the existing loan, depending on the type of loan used to refinance the existing debt. Calculating the up-front, ongoing, and potentially variable costs of refinancing is an important part of the decision on whether or not to refinance.

 

Points

Refinancing lenders often require an upfront payment of a certain percentage of the total loan amount as part of the process of refinancing debt. Typically, this amount is expressed in "points" (also sometimes called "premiums"), with each "point" being equivalent to 1% of the total loan amount. Therefore, if the refinance option selected involves paying three points, then the borrower will need to pay 3% of the total loan amount upfront. Most refinancing lenders offer a variety of combinations of points and interest rates. Paying more points typically allows one to get a lower interest rate than one would be capable of getting if one paid fewer or no points. Alternately, some lenders will offer to finance parts of the loan themselves, thus generating so-called "negative points" (also called discounts).

The decision of whether or not to pay points, and how many points to pay, should be taken in consideration of the fact that with points, one tends to trade a higher upfront cost in exchange for a lower monthly premium later on. Points can be paid out of the cash saved by refinancing the loan in the first place.

 

Types

No-Closing Cost

Borrowers with this type of refinancing typically pay few upfront fees to get the new mortgage loan. In fact, as long as the prevailing market rate is lower than your existing rate by 1.5 percentage point or more, it is financially beneficial to refinance because there is little or no cost in doing so.

However, what most lenders fail to disclose is that the money you save upfront is being collected on the back through what's called yield spread premium (YSP). Yield spread premiums are the cash that a mortgage company receives for steering a borrower into a home loan with a higher interest rate. The latter will even eventually lead to borrower's overpaying.

Cash-Out

This type of refinance may not help lower the monthly payment or shorten mortgage periods. It can be used for home improvement, credit card and other debt consolidation if the borrower qualifies with their current home equity; they can refinance with a loan amount larger than their current mortgage and keep the cash difference.