Advantages and Disadvantages of Refinancing

Refinancing your mortgage is when you get a new mortgage loan out and use the money from the new loan to pay off your old mortgage loan. In some cases refinancing home loan options are a good idea, and in some cases, refinancing your home loan is not such a good idea. Sometimes, refinancing your mortgage may cost you more money in the long run.


1. Advantages of Refinancing

When the Federal Reserve is cutting interest rates to try to stimulate the economy, you may be wondering if refinancing your mortgage is a good idea. Refinancing home loan options may help you to save money if you are able to get a lower interest rate. You may be able to switch from an adjustable rate mortgage to a fixed rate mortgage with a similar interest rate.

There are advantages in refinancing your home loan if you are planning on staying where you are, and you are currently unable to make your mortgage payments because your adjustable rate mortgage reset itself at a higher interest rate. In some cases, you may pay more over the course of your loan, but this can balance out with the lower payments. Overall, you will want to make sure that refinancing mortgage options will give you lower payments over the course of your loan, or that the savings with the lower payments enable you to save enough money to make up for the cost of refinancing your mortgage loan.

Shopping around for a low fixed rate mortgage can give you low set payments rather than ones that adjust every few months or years. You may be able to find a "no points, no closing costs" mortgage while you are shopping around for a new mortgage. In this case, you will want to thoroughly check the terms of the new mortgage loan to verify that there are no hidden fees or other issues that can cause problems with your refinance.

2. Disadvantages of Refinancing

In some cases, the disadvantages of refinancing your home loan outweigh the advantages of refinancing. If you are not planning on staying in your home, then refinancing your mortgage can be a very bad idea. As a general rule, the first few months' payments are directed toward the cost of refinancing your home loan. This can mean that you lose money in refinancing your mortgage.

Another time that refinancing your mortgage would be a disadvantage is if you extend the term of the loan. If your mortgage was originally 15 years and you extended it to 30 years with the refinance, you will pay more over the course of the loan. This may seem like an obvious statement, but it's easy to get blinded by the lower payment without looking at the payments over the course of the loan. Unfortunately, this is what got a lot of people in trouble with the sub-prime mortgage mess that the media is focusing on right now.

In some cases, though you may not be able to afford your current payments, refinancing your mortgage is not an option. This is especially true if the value of your house has gone down, but the amount you owe hasn't gone down proportionately.

3. When Refinancing is Cheaper

It may be difficult to decide when refinancing your mortgage is a good idea. If your mortgage is less than the current appraised value of your home, you may find refinancing your mortgage to be a good idea when the interest rates are going down.

You may refinance for the same amount of time, but a lower interest rate. This can reduce your monthly payments, which would give you more money short term. You may refinance your loan for a shorter term and a shorter interest rate. In both cases, you will save your interest charges minus any refinancing fees. You will need to use a financing calculator online to sort out if it is worth it for you to refinance to the lower interest rate.

When refinancing your home loan, you may decide to refinance the current balance of your loan for the same amount of time as your original loan yet at a lower interest rate. Though this will reduce your mortgage payments, if you are disciplined, you can save yourself more in the long run by paying the same amount as you were paying on your old mortgage.

4. No Cash vs. Cash-Out Refinancing

In a no-cash refinancing situation, your new mortgage will be for the amount of your current mortgage plus closing costs. In this case, you can generally borrow up to 95 percent of your house's appraised value. If you are having problems making payments on your current mortgage, this may be the best choice for you.

In refinancing your mortgage, you may borrow more than you currently owe on your house, this is known as cash-out refinancing. With cash-out refinancing, you may be able to borrow up to 75 or 80 percent of the appraised value of your house. The money that is left over from paying off your current mortgage can be used to pay other bills, for example a credit card bill, or your car loan.

There are some major advantages to refinancing your mortgage with a cash-out option. You would normally have a lower interest rate on your new mortgage, so you could pay less over the term of your loan. Unlike credit card payments or car payments, mortgage interest is tax deductible.

However, if you pay off your credit card only to build the balance up again, a cash-out refinance is not a good idea. In this case, a cash-out option will have made more problems for you because you will owe more on your house than you did when you started refinancing your mortgage.

5. Refinancing Fees

While refinancing your mortgage, points are 1 percent of your new mortgage amount. With a cash-out refinance option, any points you are charged are generally deducted from the extra amount that you receive from refinancing your mortgage.

If you can afford it, and if you are going to stay in your house for more than just another few years, it is a good idea to try to pay the points when you are refinancing your mortgage. Mortgage companies will generally charge 1 point for originating or starting your loan. Additional points may be charged if you are offered an interest rate lower than the current market value for interest rates. This allows the lender to recoup some of the money they lose from a lower interest rate.

Other than points, refinancing your mortgage will include several other costs. Closing costs are the fees that the bank charges to close your loan. An appraisal fee is charged for sending an appraiser to the house and land to give the bank an idea of the current value of your home. The bank or mortgage company will do a title search to verify there are no other claims on the house or land.

Finally, in refinancing your mortgage, the bank may insist on private mortgage insurance (PMI) if the amount of the new mortgage including fees and closing costs is more than 80 percent of the appraised value of your home.

6. Costs With a No-Cost Loan

Refinancing your mortgage with a no-cost loan can be tricky if you do not ask the right questions. Keep in mind, a no-cost loan may not be entirely what it seems. If you go to a mortgage broker or bank because of an advertised no-cost loan, you will want to talk to the lender regarding what they consider a no-cost loan. A true no-cost loan should mean that the lender covers the settlement costs for your old mortgage and does not charge you any fees to cover their expenses.

A "no cash" loan may mean that the lender is increasing the loan amount to cover all fees, and a "zero fees" loan may mean that the lender does not charge any fees for refinancing your mortgage, but you are responsible for fees to someone else.

Even when you are refinancing your mortgage with a no-cost loan, you will be responsible for some fees. For example, you will be responsible for making sure that your homeowners insurance is paid during the term of the refinance. You will have to pay any transfer taxes, and any interest from the closing day to the first day of the following month. Additionally, you will be responsible for the interest that accrues on your old mortgage from the beginning of the month until the refinance has been completed.

7. When is a No-Cost Loan Best?

If you are considering refinancing your home loan, you need to ask yourself several questions. First, are you either planning on staying in your home for only another few years? Or do you want to refinance your home loan again in another few years? If the answer is yes to either of these questions, then a no-cost loan is the way to go.

If you are planning on staying in your home for more than another few years, and you are concerned about the interest rate when refinancing your home loan in another few years, you will get a lower interest rate if you pay the refinancing fees when you refinance your home loan.

8. Choosing a Refinancing Lender

When refinancing your home loan, you want to contact your current mortgage lender last. You may have more problems refinancing with them, as they do not have a vested interest in helping you find a lower interest rate. With a lower interest rate, they earn less money off your mortgage loan. Many lenders know that when you telephone to get the balance due on your loan, you are refinancing your mortgage loan. To keep your business and your money coming in, they will offer to help you with a refinance. Many lenders have a department called a retention department that will contact you to offer to help you with refinancing your mortgage.

When your current lender still owns your mortgage, and you have been making your payments on time, you may not have to refinance your home loan. In some cases, if you are not looking for a cash-out loan, the lender that owns your mortgage may decide to reduce the interest rate on your mortgage without going through the process of refinancing your mortgage.

If your mortgage has been sold to a federal agency, refinancing your mortgage will have to go through their procedures. These agencies have what they call a "streamlined refinancing" procedure. Unfortunately, you may not have as many options when refinancing through these lenders.

9. Scams in Refinancing

In most cases, refinancing your mortgage will be done through legitimate companies. Recently some predatory lenders have cropped up with a new scam. In most cases, the borrower and a mortgage broker are scamming the lender. Unfortunately, this is not the only type of refinance scam going on out there.

A predatory lender or mortgage broker will contact someone who has purchased a home at a low rate. If the person does not know the terms of their current loan, or if they are strapped for cash, they may fall for the scam.

The predatory lender will offer to refinance the person's mortgage with a cash-out option. This is very tempting for someone who does not have much money and is not accustomed to thinking of the future. If a person or family are used to living paycheck-to-paycheck, when they are offered a large amount in a cash-out refinance, chances are they will accept the refinance. Unfortunately, many who got their house through Habitat for Humanity will fall for this scam. As a general rule, they will look at the proposed lower payment and up front cash offered, and they will not see the balloon payment at the end of the term of the loan.

When refinancing your mortgage, this is why a financial advisor will tell you to read the terms of your refinance carefully.
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