Pros and Cons of Refinancing Your Mortgage
By Murray Anderson
If you're like many of us, you've got a mortgage on your home and you plod along making your regular monthly payments. However, maybe you've heard about someone in your family or someone at work that refinanced their mortgage and claims to have saved thousands of dollars. Unlike many of these "get rich quick" stories, they just could be telling the truth. Refinancing your mortgage can dramatically improve your finances.
Right now, mortgage rates are low and an old rule of thumb says if prevailing mortgage rates are 2 points lower than your existing mortgage rate, you should consider refinancing. Refinancing your mortgage could save you significant money over the long run. Alternatively refinancing could provide you with a source of capital to reduce your debt, improve your home or make
a large purchase (like that new car to replace your eight year old rust bucket). However, mortgage refinancing isn't a magic bullet and you need to figure out if it's right for you.
How do I save money by refinancing my mortgage?
Some of the advantages of refinancing your mortgage could be,
You could make lower monthly payments.
You could build equity in your home faster (if you continue to make the same payments based on a lower mortgage interest rate).
If you have an adjustable rate mortgage you could lock into a fixed rate mortgage and gain the security of knowing what your mortgage payments will be for the life of your mortgage.
Or move from an existing adjustable rate mortgage to one with a lower rate and possibly more protective features (like better payment and rate caps).
Finally, refinancing could allow you to take advantage of some of the equity (i.e. cash) you have built up in your home over the years.
Sounds good, what are the drawbacks to refinancing?
Basically the drawbacks are costs and risk. Everyone's situation is different, and your personal situation will dictate if it makes sense for you refinance your mortgage.
Refinancing a mortgage is very similar to getting your first mortgage, so there are often numerous fees associated with refinancing. In fact, according to Lending Tree.com, because of the fees associated with refinancing, it can take over three years to realize the savings from a mortgage refinancing.
Typical refinancing costs and risks
Fees related to refinancing likely include origination fees, title searches, survey fees, property appraisals and in addition, the lender may want "points" or an up front payment of a percentage of the property's value. All these fees together can run into thousands of dollars. If you're planning on staying in your house for a number of years, it may be worthwhile to pay the fees to get a lower mortgage payment. However, if you're thinking of selling in the next few years, your monthly savings may not recapture the fees.
You may be able to save some of these fees by dealing with your present mortgage holder, but they are under no legal obligation to reduce the fees. Also don't be fooled by ads talking about no fee mortgages, all mortgages have fees, they just call them something else or add the cost to the interest rate.
Your existing mortgage likely has a prepayment penalty built into it, so you will need to pay that to get out of your first mortgage.
Finally there is always the risk that your home could go down in value and you could end up with a mortgage bigger than the value of your home.
Refinancing as a source of funds.
While refinancing can provide a ready source of funds (a cash out mortgage) for large expenses, the fees can be a major deterrent. However you may not have to pay refinancing fees to unlock some of your home equity. As a homeowner you have other sources of funds available to you, such as a second mortgage, a home equity loan (a HEL) or a home equity credit line (sometimes called a home equity line of credit or HELOC).
While a second mortgage puts an additional mortgage on your home (and will require higher total monthly payments), you will receive money in a lump sum usually with a fixed interest rate and fixed monthly payments. The advantage is, up front costs won't be as high as a total refinancing of your mortgage.
Home Equity Loan
Similar to a second mortgage, you receive a lump sum of money that is secured by equity you have in your home. Again interestis usually a fixed rate (usually close to prime rate plus a margin of 1 - 2%) and is repaid through regular monthly payments.
Home Equity credit line
Unlike a second mortgage or a home equity loan, a home equity line of credit allows you access to money as you need it(usually through checks or credit cards). The money you borrow from the credit line is once again secured by the equity you have in your home. You only pay interest when you have an outstanding balance, and the interest rate charged is usually based on prime rate plus a 1-2% margin.
Any of the above options that use your home equity as a basis for guaranteeing a loan will have some set up fees associated with them. The good news is, they shouldn't be as high as the costs for refinancing your mortgage. Another drawback to most home equity loans is they impose some restrictions on what you can do with your home while the loan is outstanding, for example, you might not be able to rent out your house. Plus, the loan obviously needs to be repaid if you sell your house.
However, for many people looking for a source of funds, home equity loans with their flexibility, lower costs and limited hassles can be just what they need. An added bonus is that and in many cases, the interest paid on home equity loans is tax deductible.
Undoubtedly, refinancing your mortgage can improve your personal financial situation. However, refinancing isn't for everyone. You need to evaluate the costs for refinancing and determine if the payback from refinancing will be fast enough or large enough to make sense for you. Also, remember, if you're looking to tap into your home equity, refinancing isn't your only option.
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