How Does Refinancing Work?

What is a refinance?

A refinance is a method used by an individual or company which allows them to revise the nature of their liabilities by getting a new loan with more desirable terms that will pay off the old loan. People can refinance liabilities such as their mortgage, car loan or any other loan with undesirable terms.

Let’s explain how a refinance works with four different stages:

  •     You currently have a loan
  •     You get a new loan
  •     The new loan pays the first loan
  •     You must now pay the new loan

You can refinance your loan with the same bank/lender or get a mortgage from a new source. Shop around and take a look at the variations in interest rates across different lending companies and banks. Searching the web can also give you valuable information regarding current interest rates for most mortgages. Knowing what qualifies as a fair rate will protect you from getting ripped off by a loan shark who plans to trap you in the deadly jaws of debt.

Benefits to refinancing your mortgage

Refinancing your home can bring many short-term and long-term benefits. The reason thwat most people refinance their mortgage is to secure lower interest rates. Having a lower interest rate on your mortgage will make it easier to build up your home’s equity. Lower interests fees also raise your net worth by reducing liabilities.

Another benefit that refinancing your mortgage brings is the ability to shorten the term of your loan. If you refinance a 30-year mortgage with 20 years remaining with a 15-year mortgage then you’ll be able to pay off the loan sooner which will save you a lot of time and money. When attempting to shorten the term of your loan make sure to pick a time when interest rates have dropped significantly to avoid severely raising the amount of your monthly payments.

A refinance is an opportunity to change the terms of your mortgage. One of the most important things to consider when refinancing a home is if you want to change from a fixed-rate mortgage to an adjustable-rate mortgage or the other way round.

Switching from an adjustable-rate mortgage to a fixed-rate mortgage can be beneficial if interest rates have dropped by 2% or more since you secured your old loan. Remember that the bigger your balance is, the more each percentage saved on your interest matters. 2% savings on a $1,000,000 home is more significant than 2% savings on a $200,000 home.

A cash-out refinance is where you get a new loan that is a higher amount than your original loan. This will get you some extra cash and can be handy if you’re in a sticky situation. Decide whether or not tapping into your home’s equity and increasing your total balance is worth it just to get some extra cash. Never get a cash-out refinance just to go shopping or buy a luxury car.

Should you refinance your mortgage?

There are many factors to consider when deciding whether or not a refinance is worth it for you and the answer will vary from person-to-person.

An important factor to consider is age. As you get older, you get nearer and nearer to retirement. Most retirees receive a lower income than those who are still working so refinancing your home and ending up adding more years to your mortgage can become a problem if you are no longer able to sustain such payments during your retirement.

Check if the benefits of refinancing your mortgage outweighs the costs. Refinancing your home can deplete your home’s equity, add years to your loan, and get you charged with penalties for early payment of the loan. Make sure that lowering the interest rate will still be worth it after all the time and money it takes to refinance your home.

If you truly believe that refinancing is the best option for you then try to kill as many birds as you can with a single stone. If refinancing is executed properly you can shorten your mortgage term, lower the interest, and switch from an ARM to a fixed-rate mortgage or from a fixed-rate mortgage to an ARM all in one swift blow.

What you’ll need

In order to refinance your home, you’ll need to meet a few basic criteria to be eligible. Your credit score should be good… usually 600+.

Check to see if you have enough home equity to afford a refinance. Refinancing will take a chunk out of your home’s equity so make sure that you’ll still hold a 20% equity stake in your home after the refinance.

Make sure that you have enough savings to cover any closing fees, call provisions, or balloon payments upon retiring your old loan and replacing it with the new one.

If you do not meet the criteria above you should consider getting an FHA streamline refinance or a VA refinance if you qualify. FHA and VA loans typically have more flexible requirements as far as eligibility and credit scores go.

The bottom line on refinancing

Like anything in life, refinancing comes with its pros and cons. Refinancing your mortgage can be beneficial for you if you’d like to reduce your liabilities and shorten your loan’s term but make sure to consider both the advantages and disadvantages.

Just remember that some things never change, refinancing your home won’t get rid of your debt, your collateral is still at stake, and you’ll still need to make monthly payments. Do your homework before applying for a refinance and consider getting a professional consultation from a well-trained financial advisor who specializes in mortgages.

That’s the ins and outs of refinances. We hope that we’ve answered any questions that you might have but if you have any other concerns then don’t hesitate to send us an email. We’re always happy to hear from you and our response team will get back to you within 48 hours of receiving your email.

Get a personalized loan consult with one of our experts today.