What is Refinancing?
Refinancing is the process by which a borrower replaces an existing loan with a new loan on more favorable terms. This is typically done through a bank or other lending institution. It could be that you need to change your mortgage term, decrease your interest rate, add features to your loan agreement, or swap loans from one type of lender to another.
Why Refinance?
Refinancing your Home Equity Loan will enable you to change the terms of your current loan or choose a different type of loan. For example, if you have a 30-year mortgage and you want to take out a new loan with a shorter term, refinancing provides an opportunity for you to do that. Your monthly payments for the new mortgage loan would be lower than the old one, and you would build equity in your home twice as fast.
Refinancing could also enable you to consolidate two or more high-interest debts (like credit cards) into one low-interest debt (like a mortgage). The short-term cost savings for this consolidation may be very attractive.
If you’re in the right situation, a refinancing home equity loan could help you make your monthly obligations more manageable. You may be able to lower your monthly payments, increase the amortization period of your loan, or increase the amount of interest paid overtime. If you think refinancing could help you make ends meet, consider that it is an opportunity to save money and get ahead financially when times are tough.
Pros of Refinancing
1. If you can get approved for a new home equity loan with a lower interest rate, you will likely save quite a bit of money over time.
2. Having more time to build up equity in your home can potentially increase the value of your home and make it more comfortable to sell.
3. Qualifying for a mortgage with a shorter term of 15 years can save money on interest payments and enable you to pay off the loan faster, saving you money on interest.
4. Switching from one type of loan to another can allow you to find the mortgage that is right for your needs and get rid of any high-interest debts that are causing trouble in your life.
Cons of Refinancing
1. There are fees associated with refinancing loans which may include appraisal fees, application fees, underwriting fees, credit report fees, attorney fees, and closing costs.
2. If you have a second mortgage on your home, paying off that loan may give the bank the right to take extra payments out of your checking or savings account.
3. If you take out a new loan with a lower interest rate and want to refinance again in a few years, you may be taking on several points of interest during the interim periods between loans and paying an even higher rate on the second loan.
4. When it comes time for your next refinance, you could lose some of your valuable home equity if you paid down the principal too much before signing up for another loan.
5. Even though you may want to pay off your home equity loan early, you could be charged a large prepayment penalty if you try to do so.
6. If interest rates go up, you’ll end up paying much more on your monthly payments than you would have originally.
Benefits of Mortgage Refinancing
1. You could lower your monthly mortgage payment and extend the amortization period of your loan, which could save you thousands of dollars in interest over the long term.
2. By refinancing with a smaller interest rate, you could pay off one or more of your high-interest debt faster and save money on interest.
3. You could have a shorter term on your mortgage and build up equity faster than you would have done if you had taken out a longer home equity loan that paid higher interest rates.
4. You could consolidate two or more high-interest debts into one low-interest debt through the refinancing process.
Why Refinancing is a Bad Idea?
Refinancing your loan can be a great idea if you’re in the right situation and you’re able to get approved at a good rate. However, some downsides could make refinancing a bad idea for you.
You could lose money on the transaction because of fees associated with refinancing, including application and appraisal fees, attorney fees, title search fees, underwriting fees, credit report fees, and closing costs. In addition to these costs imposed by private lending institutions, there may also be closing costs charged by the county or state in which your property is located. Local governments charge “transfer taxes” to help pay for their ongoing operations. These transfer taxes are usually between 1% and 2% of the home’s value.
If your previous lender has a second mortgage on your home, you may have to pay that debt off before any refinancing can occur. But in doing so, you may lose money at the end of the day because you’ll have to make extra payments out of your bank account or you’ll lose over time by paying more interest. In addition to losing money when paying off secondary loans, there could be an additional fee that’s charged by the new mortgage loan company for assuming responsibility for another loan.
When Refinancing Do You Have to Pay Closing Costs?
In certain states, the number of your closing costs will be included in the “points” that you need to pay to the lender. In other states, however, you’ll have to pay closing costs separately at settlement. If a second mortgage is on your home and you refinance that home equity loan, you may have a higher interest rate as a result of assuming responsibility for a second loan.
If you plan to refinance and are not sure if the closing cost is covered by your lender or not, it’s best to ask them before signing up for new home equity loans. They should be able to tell you whether the point charges are taken from your loan amount or if they are separate and additional fees that need to be paid in addition to yours.
Can You Pay Closing Cost on Top of Loan?
If your lender will not be covering your closing costs, you’ll most likely want to make sure that you have enough savings in the bank to pay these fees yourself. You can save money and get a lower interest rate if you can pay off extra money before applying for a new loan.
According to the Mortgage Bankers Association, some lenders will allow borrowers to finance closing costs and points into their new loan amounts. Although this practice is common in situations where a second-mortgage holder wants to refinance and assume responsibility for their debt, it’s not as common in situations where borrowers want to refinance home equity loans without assuming any additional loans.
