Refinancing is the process of replacing simply a loan you already have with another loan. It can happen with your current lender or you may go to a different lender.
In other words, refinancing is a term that refers to the process of paying off a current or present loan with a second loan in the finance industry. For those who engage in refinancing, it can be very beneficial if the situation is right.
Several reasons are there that you may think about refinancing as an option including to save money on your home loan, to borrow more money, to save money on your other loans, or since you are in financial difficulty.
Providing that you take into account the actual cost of refinancing in your calculations, refinancing can be a great way to save money. But there can be many pitfalls. Refinancing due to your financial difficulty is particularly risky and you should always get advice first.
If the interest rates are low, then only refinancing works. If they aren’t, then refinancing is impossible. The goal is to save you lots of money, which you would have used to pay off your monthly recurring bills on your current loan.
There is the possibility that this monthly repayment amount will be reduced since the rates would be considerably lower with refinancing.
Refinancing may not always be useful to people due to this inherent flexibility of interest rates. Mortgage refinancing may backfire for homeowners with second mortgages.
The same goes for those people with a lot of debt or those having trouble paying their bills on time. When they stick to the loan they already have, by refinancing, they may end up paying more amount.
Things to Consider Before Refinancing
It is very difficult to being in financial difficulty. If you are behind on your mortgage repayments, it can be very difficult to negotiate with your lender who may be threatening to take your home.
Even if you are managing to make your mortgage repayments, but other creditors are pressuring you, it can seem like the easiest option is to refinancing your home loan and consolidate your debts to get everyone off your back.
Think about the following options before refinancing.
- Refinancing always costs money. If you are in financial difficulty now, you will nearly always be better off financially if you can come to an arrangement with your existing creditors. See a financial counsellor, if you can’t negotiate an arrangement yourself.
- If you cannot pay this loan, you will lose your house since you are placing your home on the line.
- You are cutting off options that may have been available to you such as surrendering your car (for car loans) or negotiating a reduced debt or repayment arrangement with your credit card company.
- Refinancing your credit card debts (for example) might save your skin (at least for now), but it usually won’t save you money and it won’t stop you running up more debt afterwards (especially if you are struggling to make higher home loan repayments).
- Beware of lenders of last resort.
Depending on your financial objectives, there are many advantages to refinancing. If your goal is to refinancing with the lowest monthly payment, many mortgage offers can help you do this.
Loan offerings may help you if your goal is to build equity and quickly pay down your mortgage balance. For any variety of reasons, you can refinance and take cash back, if your goal is to cash out equity in your home.
Finally, mortgage options are going to help you if your goal is to protect yourself from the economy and preserve your peace of mind.
Types of Loans Considered For Refinancing
When homeowners are considering the possibility of refinancing their home, they have quite a few options available to them.
- Fixed Rate Mortgage
- Adjustable Rate Mortgage(ARM)
- Hybrid Loan
Among those three, fixed rate mortgages and adjustable rate mortgages (ARMs) are the two main types of mortgages the homeowners will likely encounter.
Fixed Rate Mortgage
A fixed rate mortgage as the name implies, is one in which the interest rate remains constant all through the duration of the loan period. When the homeowner has credit that is sufficient to lock in a low interest rate, this is an exceptionally favorable type of loan.
Adjustable Rate Mortgage
ARMs or Adjustable Rate Mortgages are mortgages where the interest rate varies during the course of the loan period. The interest rate is usually tied to an index such as the prime index, is subject to rises, and falls in accordance with this index.
This is considered a riskier type of loan and is therefore often offered to homeowners who have less favorable credit scores.
Although ARMs are considered somewhat risky, there is usually a certain degree of protection written into the loan agreement. This may come in the form of a clause, which limits the amount the interest rate can increase, in terms of percentage points, over a fixed period of time.
This can protect the homeowner from sharp increases in the interest rates, which would otherwise considerably raise the amount of their monthly payments.
Hybrid loans are mortgages, which combine a fixed element with an adjustable element. An example of this type of loan is a situation where the lender may offer a fixed interest rate for the first five years of the loan and a variable interest rate for the remainder of the loan.
Lenders typically offer a lower introductory interest rate for the fixed period to make the mortgage seem more enticing.
Consider the Closing Costs
The closing costs associated with re-financing should be carefully considered when deciding whether or not to re-finance the home. This is significant because when homeowners re-finance their home they are often subject to many of the same closing costs as when they originally purchased the home.
Consider the Overall Savings
When deciding whether or not to re-finance, the overall savings is one factor the homeowners should carefully consider. This is important because re-financing is typically not considered worthwhile unless it results in a financial savings.