Refinance is just a simple term for cancelling one home loan and securing another. Obviously, you will consider refinancing when available interest rates fall about half a percent below the rate you currently pay on your home mortgage. First, you need to measure the savings over the life of the loan against the cost to do the refinance.
When you talk to a loan officer about refinancing, he or she should tell you how much you would save on your monthly payment. You would then figure how long before these “savings” would pay for the cost to close. You should intend to be in the house for longer than it takes to recover your closing expenses in order to have any real monthly savings.
A refinance can offer you a lower monthly payment. Or some borrowers refinance to a lower rate and keep their monthly payment the same, in order to pay off the loan faster. Some need the money to pay for college tuition or medical bills.
A lower payment refinance example:
- Initial loan $250,000 on 30-year fixed rate loan at 5% with monthly payment of $1,342
- Principal and interest payment $1,342 a month
- Current loan balance $229,500
- Remaining term 25 years
Reduce monthly payment
- Refinance mortgage 30-year fixed at 4.5% with no closing costs
- New loan $229,500 on 30 year at 4.5% with monthly payment of $1,163
- Monthly savings of about $179
The borrower can spend the monthly savings or apply it to the mortgage payment to pay off the loan faster.
A cash-out refinance is when you have a significant amount of home equity, meaning your home is worth over 10 percent more than you owe on the mortgage. Then you can refinance to take cash from equity. Home owners do this typically when they need to pay for college, or pay off student debt, or perhaps do a home renovation. A cash-out refinance may lower your mortgage rate, but it will extend the life of your loan because it will increase the amount you owe.
A refinance to consolidate debt would only be wise with a lower interest rate. If you have a home mortgage and a home equity line of credit, these two loans have different interest rates. It could make sense to combine the two into one loan to lower your rate. The value of your home would need to be greater than the combined debt.
Other debt to consolidate may include student debt or high interest credit card debt. By paying off student loans and credit card debt you may have the added benefit of improving your credit score. You will most certainly have the added benefit of eliminating high credit card interest rates.
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