Refinancing Mortgages and Loans

Key Takeaways:

• Refinancing involves replacing an existing loan with a new loan that offers better terms.

• Common types of refinancing include mortgage refinancing, car loan refinancing, and student loan refinancing.

Table of Contents:

1. Types of Refinancing

2. Refinancing a Mortgage

3. When Does Refinancing Make Sense?

4. Pros and Cons of Refinancing

What is refinancing? Refinancing refers to obtaining a new loan to replace an existing loan. People choose to refinance when they can secure a new loan with improved terms compared to their current loan. The benefits of refinancing typically include:

• Lower interest rate

• Smaller monthly payment

• Fixed interest rate

However, it's important to consider that refinancing usually comes with costs and should only be pursued if the benefits outweigh the expenses.

Types of Refinancing:

There are four common types of refinancing:

1. Rate and term refinance: Replacing a loan with another loan of the same amount, often to achieve a lower payment or interest rate.

2. Cash-out refinance: Replacing a loan with a larger loan and receiving the difference in cash. This is often used to cover expenses such as education or home improvements.

3. Cash-in refinance: Replacing a loan with a smaller loan by bringing in cash to reduce the loan balance. This is done to eliminate mortgage insurance or lower the loan-to-value ratio.

4. Debt consolidation refinance: Using one loan to pay off multiple accounts, typically used to consolidate high-interest debt into a single loan with a lower interest rate.

Refinancing a Mortgage:

Mortgage refinancing is a common type of refinancing, as mortgages are usually significant loans with long repayment periods. Even a slight decrease in interest rate can result in substantial savings over the life of the loan. Ways to save money through mortgage refinancing include:

• Refinancing to pay less interest: Taking advantage of lower interest rates or improved credit scores to secure a loan with better terms.

• Refinancing for a lower mortgage payment: Lowering the monthly payment through a lower interest rate, extending the repayment period, or dropping mortgage insurance.

• Refinancing to pay off a second mortgage: Consolidating multiple mortgages into a single loan, potentially reducing interest and monthly payments.

• Streamline mortgage refinancing: Simplifying the refinancing process by eliminating certain requirements such as appraisal or credit checks, commonly available for government-backed mortgages.

When Does Refinancing Make Sense?

Refinancing is a sensible choice when it achieves your desired goals. To determine if refinancing will save you money, calculate the refinance breakeven period. This period represents the time it takes for the monthly savings to cover the refinancing costs. If you plan to keep the new loan beyond the breakeven period, refinancing will result in savings.

It's important to note that extending the repayment period can increase the overall costs, even with a lower interest rate. Consider the long-term impact and assess if the refinancing aligns with your financial objectives.

Pros and Cons of Refinancing:

Before proceeding with refinancing, it's crucial to consider the advantages and disadvantages.

Refinancing Pros:

• Potential reduction in interest expenses with a better rate.

• Possibility of lowering monthly expenses.

• Access to cash at a reasonable cost.

• Option to switch from a variable interest rate to a fixed rate for better cost control.

Refinancing Cons:

• Incurs expenses, even with "no-cost" refinancing options that come with higher interest rates.

• Extends the time to pay off the debt, potentially increasing overall interest costs.

• May require application and documentation of income and assets resulting in additional effort.