Home loans are lengthy obligations, and because of this the landscape upon which one is initially based may change over time. Refinancing refers to the alteration of the conditions of a loan to better suit the landscape as it currently lies. An initial or purchase-money loan is an original loan applied for and secured by a borrower in order to purchase a home. A refinance, then, is a new loan with new conditions which will then be used to pay off the old loan.
Why do people refinance?
A homeowner’s right to refinancing will depend on similar factors to those considered when applying for a home loan, as well as their history of meeting payments on an initial loan. In general, people seek out refinancing on a home loan because they are undergoing financial difficulties and need to alter the conditions of the loan or free up case. Though sometimes, borrowers will simply seek out refinancing to update the loan and acquire a better rate.
The various reasons for refinancing a home loan:
- To take advantage of a better interest rate than the one currently being paid, either reducing the monthly payment or the term of the loan.
- To consolidate various debts into one single loan, that may be entitled to a single, lower rate than the one that is being paid.
- To reduce the monthly repayment amount; if for example a borrower is having difficulty meeting payments, they can reduce each individual payment but the term of the loan will increase.
- To reduce or alter risk, meaning to change the kind of rate that is applied to the loan: from a variable-rate to a fixed-rate loan.
- To take advantage of a property’s rising value, meaning the borrower will be able to obtain a larger home loan if the value is higher.
- To free up funds that may be required to cover other large costs, such as medical bills or college fees.
Is refinancing right for me?
When interest rates drop, people rush out to refinance their home loan. Often, this is a good idea, and borrowers end up refinancing so often that the term “serial refinancer” has been coined. Refinancing might be right for you, but rather than rush out it is often better to step back and consider your situation before making such a commitment. Refinancing is a big step – just as big a step as deciding on and securing your home loan in the first place. A lack of proper understanding of home loan refinancing can lead to poor finance management and struggles in the future.
The various benefits of refinancing a home loan:
- If you plan to stay in the home long enough to break even on refinance costs, the lower interest rate and payment that you may qualify for through refinancing can greatly improve your monthly cash flow.
- If the lower interest rate you obtain is substantially lower than your previous rate, it is possible to shorten the amortization period or term of your loan in exchange for a slightly higher mortgage payment.
- If you are in need of cash in hand, refinancing your home loan is obviously a significant option. Many will refinance and then invest the funds received at a higher rate of return than the new interest rate.
The various drawbacks of refinancing a home loan:
- Refinancing a home loan involves paying it off, and many home loans are saddled with prepayment penalties that discourage such a thing. There may be the possibility to wave this prepayment penalty when refinancing with the same lender.
- Prepayment penalties aside, costs are perhaps the biggest drawback to refinancing. Despite perhaps refinancing with the same lender, it is still costing money to obtain the loan – this may not recoup through a lower interest rate.
- Moving out of your home is another thing to consider. If you are planning to move from your home in the near future, the savings gained from lower monthly payments may not exceed the costs of refinancing.