Should you Refinance?When interest rates are low or declining, many homeowners consider the option of refinancing their current mortgage. In general, there are 4 reason to refinance your existing loan:
Interest Rate Reduction Refinance
The most common reason to refinance is to lower the interest rate and correspondingly lower the monthly payments. However, it is important to perform a "break-even" analysis that takes into consideration three factors:
The break-even analysis requires you to take the amount of the Closing Costs of the refinance loan and divide this amount by the monthly savings. This number is the number of months it will take to "recoup" the cost of the refinance. Next you simply consider whether you think you will be in this new mortgage for this amount of time. If you do, it makes sense to refinance.
When calculating the amount of the Closing Costs of the refinance, it is very important that you do not include any Prepaid Closing Costs that may be part of the refinance.
Cash Out Refinance
Refinancing your loan and taking cash out of the transaction is often a financially sound decision.
If you have consumer debt such as credit cards, installment loans, or car loans you should strongly consider shifting it to mortgage debt. Mortgage debt is typically tax deductible, and the interest rate on mortgage debt is almost always lower than the interest rate on consumer debt, which means less interest and lower payments on a mortgage.
Most lenders will allow you to use the cash you take out of the transaction for any reason home improvements, lifestyle events (pay for childs tuition or wedding), invest in the stock market, or maybe just a vacation.
Loan Type Change Refinance
Homeowners with adjustable rate mortgages (ARMs) or balloon mortgages will often refinance to change their loan type to a fixed rate loan.
By their nature, both ARMs and balloon mortgages provide more risk to the consumer. With an ARM, the interest rate can increase, and thus the payment will increase. ARMs with adjustments semi-annually or annually will typically start with low "teaser rates", and then adjust upward very quickly, even if interest rates dont change.
Balloon mortgages require the loan be paid off at some time in the future, which in most cases requires the homeowner to refinance the loan.
While both ARMs and balloon mortgages have their advantages, it is not uncommon for homeowners to take advantage of periods of low interest rates and relieve themselves of the risk associated with these loan types by refinancing into fixed rate mortgage. Savvy homeowners who have ARMs or balloon mortgages will be pro-active and refinance before their interest rate adjusts upward or the balloon payment comes due.
Another common reason to refinance is to shorten your mortgage term. Many homeowners are comfortable with their current mortgage payments, and will take advantage of declining interest rates by keeping their payments the same but shorting the term. Besides paying off the loan faster, shortening the term also reduces the interest you will pay over the term of the loan.
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