Refinancing Your Home Loan

Perhaps you are carrying a high interest rate on your home loan or you need an infusion of cash. Either way, you might have been thinking about refinancing, but you’re not quite sure. As you decide, you may want to keep the following considerations in mind.

What does refinancing involve?

When you refinance, your existing home loan is paid off and replaced with a new one. Your new loan can be equal to the balance you owe or more than the balance owed. If it’s more, you do a cash-out refinancing, in which case you pocket the difference between the amount owed and the amount borrowed. No matter which option you choose, you will need to qualify for the loan, going through an application and approval process just as you did when you got your existing loan. In addition, unless you find a suitable no cost refinancing program, you will incur closing costs.

What are some reasons for refinancing?

One of the more obvious reasons for refinancing is to save money. For instance, a lower interest rate than the one you have can save you money over the long-term. Other reasons include:

Replacing an adjustable rate mortgage with one that has a fixed rate to avoid the risk of fluctuating, and potentially higher, future rates
Getting a shorter loan term to reduce total interest paid and to build equity faster
Cashing out some of the equity in your home to cover big ticket items like college education and major home improvements

When is refinancing worth it?

Whether or not refinancing makes sense for you depends on factors such as potential savings, up-front costs, and length of time you plan to stay in your home. Simply stated, you need to look at how long it will take you to realize savings from the refinance. If your plans involve moving before you recover the costs and the savings begin, then refinancing might not be the way to go. Here is a quick example:

Costs to refinance your loan = $1500
Reduction in your monthly payments = $50
Time required to break even on costs = 30 months (2.5 years)

So, if you plan to move in 2 years (24 months), then you would not have time to realize savings. If staying for 3-5 years, you would.

What should you pay particular attention to?

Here are a few tips to help you make the most of your refinancing experience:

Do your homework. Treat your refinancing just as you would first-time financing. Find out what options are available so that you can determine which one is best suited for you.
Shop around. Don’t assume that your current lender has the best deal. Look at interest rates and loan terms offered by other lenders also.
Do the math. Figure out how long it will take you to break even on costs. You will find calculators and worksheets online that can help you work through this quickly and easily.
Watch out for private mortgage insurance (PMI). If you borrow more than 80 percent of your home’s value, you could end up paying PMI. This protects the lender against financial loss if you don’t repay your loan.

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