People choose to refinance their home
loans for a variety of
reasons. The most
common is to
take advantage of lower interest rates. Some of the other reasons people refinance home loans include:
- Paying off credit cards with high interest
- Making home improvements,
- Replacing an Adjustable Rate Mortgage (ARM) with a fixed
- To make investments or for personal use, known as 'Cash Out' refinance loans,
- Rebuilding a poor or damaged credit rating.
What is involved to refinance a home loan?
Normally, when you refinance, the homeowner signs a new mortgage with the original lender or a new lender. In the same transaction, the old mortgage is paid off with the
proceeds of the new mortgage. Usually the borrower will have to pay most of the same
costs and fees incurred when the original mortgage was obtained. Depending upon the terms of your mortgage, you may
also incur a "pre-payment penalty" for paying the note off
You should consider several things
before refinancing your home loan.
- How long do you plan on staying in your home? If you plan to move in the next couple of years, the
savings may not have time to catch up to the costs involved in
obtaining the loan.
- What are the
new interest rates? As
a general rule of thumb, try to find a
rate that is minimum 2 points below your current mortgage rate,
especially if you incur significant closing costs.
- Are you refinancing during a competetive lending market, or
can you wait for one? Look for a lender that may be
willing to waive the normal fees. These include such items as application fee, legal fees and appraisal fees, points, and many small charges that can add up. When lenders are competing for loans, sometimes these fees are waived, which can save thousands of dollars. If these fees are added into
your loan, you will be paying interest on those closing costs.
Common mortgage lengths are 10, 15, 20 and 30 years. Some companies offer a lower rate for a shorter
term loan. Many people who refinance home loans intend to
build equity in their home faster by shortening the term of
the loan along with reducing the interest rate. In this case, your monthly payment will be higher even with a
The benefit is that you pay less interest over the length of the mortgage, and build equity in your home faster. For example, if you wanted to refinance a 30 year
mortgage to 15 years but the monthly payment was too
high, you may be able to obtain a 20 year
mortgage and still be able to take advantage of the lower rates.
If your goal is to reduce the total interest over the term of the loan, weigh the benefit of simply making extra principal payments on your existing loan against the additional costs of refinancing. By taking a 30-year mortgage and reducing the principal faster in the early years, you will
save a considerable amount of interest over its life while keeping the safety net of lower required payments in the event you could not make the higher payment one month.
One last important point to remember -- companies who refinance home loans are competing for your business. To an extent, you can negotiate with them.
Once you have applied for the loan, ask them to guarantee the rate so that it is locked
in at the quoted rate in case market interest rates go up during closing. Try to play it both ways -- ask them to agree to a rate
decrease if rates go down before closing. The refinance of home loans is competitive enough that companies will often agree to either or both of those
options. If they will not lock in against rising rates, you
may want to check with another company.
There is a saying in the stock market that "Money goes where it is treated best." It's your money, and you have the right to get the best deal possible. If the rates go down and they will not give you the lower rate, you don't have to close the loan. It may be time consuming and stressful to re-apply with another company, but may be worth it.
After all, the ultimate goal is to reduce your payments or to increase the equity of your home in a shorter time.