Homeowners usually fall into one of two categories – one that thinks refinancing is a great idea, and the other that thinks of the term ‘refinancing’ as a scary reality. The truth lies somewhere in the middle. As a homeowner, you should definitely refinance at the right time if it will benefit you in the long run. Financing because you’re in financial trouble, however, may be unavoidable, but it can also send you down a more expensive path. Sitting down with a realtor or financial expert can help you learn the ins and outs of refinancing, but this is information you are able to seek out on your own – and you should.
Understand the Process
Before you commit to a long-term loan that replaces your existing one, you should understand all of the jargon used in refinancing. First, know the definition. Refinancing involves the process of obtaining a new mortgage to replace the old one. Fundamentally, the old one is paid off in most cases. You will also hear the terms “rate” and “term.” Rate refers to interest rate, and the term refers to the life of the loan. Closing costs are fees you incur when you refinance. You may have been familiar with the term when purchasing your home, but they reappear with financing.
When Is a Good Time to Refinance?
Typically, you cannot refinance a mortgage loan until you’ve paid at least 12 months or one year off on the existing loan. After this period, you should give refinancing consideration if you are able to:
- Lower the monthly payment without extending the term
- Want to avoid balloon payments
- Are going through an upheaval, such as divorce
- Are able to cash out a portion of the home’s equity
Sometimes, hard times in life are unavoidable, and loss of job or a divorce may happen. This is a good time to consider refinancing, but you may have to extend the term of the loan to save money on a monthly basis in the present. Generally speaking, that is something you want to avoid.
Cashing Out for Equity
If you have owned your home for several to many years and are paying on the mortgage, there is a good chance that the value of the home has increased. This is known as a cash-out mortgage, and while it carries some risks, if you are stable financially and there is substantial value growth and equity in your home, it’s a good idea. This type of loan is typically tax-deductible, and homeowners often use this extra windfall for vacations, college expenses for their children, or for newer vehicles.
Lower Monthly Payments
It is smart to check with your existing lender several years into the loan and inquire about lower monthly payments. You are certainly able to ask other lenders as well, but if your loan is in good standing with your original lender, ask them first. This type of refinancing requires you to look at the fine print and do a few calculations. If you have to extend the term for a lower monthly payment, most likely this will not help in the long run. As aforementioned, this is fine for emergency’s sake but is not a good time to refinance. You want to look for the same term, with lower monthly payments. Another option is a shorter term with higher monthly payments, which usually ends up saving you money in the long run.
Switching Types of Mortgages
This method is tricky, and it’s best to go down this road with the help of a realtor or financial advisor. If you have a fixed-rate mortgage, switching to a 5 to 7-year ARM (balloon payment) may be a sound choice, but this also could backfire. If interest rates are plummeting, this is a good time for this type of refinancing. A more sound strategy is to switch from an adjustable rate to a fixed-rate mortgage, over the worry of increasing interest rates. If you have your eye on housing markets, switching your type of mortgage may be a good idea.
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