Three reasons motivate people to refinance. One is obvious – to save
money because interest rates have dropped. Refinancing also can be a way of
raising capital for some other purpose. A final reason is to get out of one
type of loan and into another. The following discussion should help you to
decide upon the best option in each case.
Spending money to save money.
Most people want to refinance for the same reason that they want a promotion – for
the money. When you refinance a mortgage, you have to spend money and time
to save money. So you need to crunch a few numbers to determine whether
refinancing makes sense for you.
Because refinancing almost always costs money, it's a bit of a gamble whether
you can save enough to justify the cost.
Your odds of saving money by refinancing go up a lot when
– Your current intrerest rate is quite high – above 8.5 percent
on a fixed-rate loan or 6 percent plus on an adjustable with a lifetime cap above
10 percent.
– You're planning to keep the property for at least five years or more.
Not all refinances cost tons of money. So-called no-cost refinances or
no-point loans are becoming more widely available. These may not be your
best long-term options, however. No-cost or no-point loans come with higher
interest rates.
Use the refinance calculator to calculate how many
months it will take you to recoup the cost of refinancing, such as appraisal,
loan fees and points, title insurance, and so on.
If you can recover the costs of the refinance within a few years or less,
go for it. If it takes longer, it may still make sense if you anticipate
keeping the property and mortgage that long. More than 5-7 years is probably
too risky to justify the refinance costs and hassles.
Using money for another purpose
The common logic is that refinancing to pull out cash from the house for
some other purpose can make good financial sense because under most circumstances,
mortgage interest is tax deductable.
If you're starting a business, consider borrowing against your home to
finance the launch of your business. You can usually do so at a lower cost
than on a business loan.
The most critical question is whether a lender is willing to lend you more
money against the equity in your home ( which is the difference between
the market value of your house and the loan balance). You will need to
know the calue of your property ( comparable rfecent sales in your neighborhood
can help you determine what it's worth) to understand how much more you
can borrow.
Warning: Financial guru Clark Howard,
recommends that money taken out of the house should only be used for home improvements
and remodeling. When you default on a credit card loan, the bank
can put a bad mark on your credit. If you default on an auto loan, the
bank can reposess the car, but you can probably get by using puclic transportation
if you need to. But if you shift those debts to your home, and then default
on the mortage, suddenly you're out of your home, and you will lose any equity
that you may have built up. So now you end up with nothing after what would
otherwise have been a small financial setback.
Changing loans
Sometimes, saving money or raising more money isn't the objective. You
might be forced to get a new loan. Balloon loans, which come due and
payable in full at a predetermined time, may require you to get new financing.
Or you may have bought property in partnership with others and now need
to cash out one of your partners.
In these cases, you can determine which type of loan is best for you in
the same way you do in getting a new loan. Go back and read Fixed
Rate versus Adjustable-Rate Mortgages.
There are other cases in which you mightr want to refinance even though
you're not forced to and won't save money. Perhaps you're not comfortable
with your current loan – holders of adjustable-rate mortgages often
face this problem. You may find out that a fluctuating mortgage payment
makes you a nervous wreck in addition to wreaking havoc on your budget.
Paying money to go from an adjustable to a fixed is a lot like buying insurance.
The cost of the insurance in this case – the refinance – guarantees
a level mortgage payment. Consider this option only if you want peace of
mind and you plan to stay with the property for a number of years.
Sometimes it makes sense to consider jumping from one adjustable to another.
Suppose you can lower the maximum lifetime interest rate cap and the refinance
won't cost to much. Your new loan should have a lower initial interest
rate than the one you're paying on your current loan. Even if you won't
save megabucks, the peace of mind of a lower ceiling can make it worth
your while.
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