Refinancing is a process where your existing loan is paid off by taking a new loan on the house. There are several possible reasons and benefits of refinancing:
Reduction in mortgage rate: One of the biggest reasons why most homeowners refinance is to reduce mortgage rate. If you are currently paying 4.25% on a 30 Year Fixed mortgage, it will make sense to refinance into a 4%. The important thing to watch out for is the cost involved in refinancing. If by reducing the rate, you save $50/month, but end up paying $3,000 in closing cost – it may not be worth it since it could take a long time to break even. My rule of thumb is that if you can get at least 0.25% reduction in rate at no points and no cost, it usually is a good deal if you havent paid too much interest on the existing mortgage.
Reduction in monthly payment: Other than reduction in rate you can reduce payment by lowering your loan amount and/or extending the term of the loan. For example, you are at 4.25% on a 30 Year Fixed loan with 20 years more to go. You can lower the payment even by getting a slightly higher rate but resetting the 30 year term again. While you may get a lower payment, this is not advisable since you will take an extra 10 years to pay off your mortgage.
Change in term: Sometimes you want to pay off your loan faster even if it means increase in payment. Thats when you can refinance your 30 Y F mortgage into a 15 or 20 year fixed mortgage. The lower term mortgages usually also have lower interest rates. So, you not only pay off the loan faster, you also save several thousand dollars in interest payment.
Getting a Cash-out: If you have built up enough equity in the house (usually 25% or greater), you can refinance to get cash-out. You can use this extra money to pay off other debts, remodel the house, pay for child’s tuition, go on a vacation, buy a new car or anything else thats important for you.
Getting rid of Mortgage Insurance: If you have an FHA loan where you can’t get rid of mortgage insurance, but think you have built up 20% or more equity – refinancing into a conventional mortgage would be a great idea. If you qualify, this way you can get rid of mortgage insurance.
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