What is refinancing?

Features

1. Refinancing simply means paying off one debt with another loan, using the same assets as collateral. Most home or car purchases are financed with terms that extend for a certain period of time at either a fixed or adjustable interest rate.
   In a refinancing situation, a new loan is borrowed to retire the original mortgage, usually at a lower rate or longer period or both, often creating a lower monthly payment for the mortgagor.
   Credit card debt can also be informally refinanced by renegotiating terms or transferring a balance to another card, but the term is seldom applied to such situations.

   Function

2. Refinancing is voluntary, so it almost always serves to provide some value to the borrower. If the cost of refinancing is less than the potential savings, the difference can be a major motivation to refinance.
   In other cases, refinancing is simply used as a way to tap into home equity, especially when mortgage rates are lower than comparable lines of credit. Because the borrower is putting up his home as collateral, he can usually borrow the full market price of the house. If the amount of the first mortgage is less than the market value, the difference is equity.

   Significance

3. Financing and refinancing have been providing flexibility to modern capitalist economies for a long time, allowing owners to take advantage of low rates and cheap credit. From 2002 to 2006, refinancing homes became a major source of funding to U.S. households, resulting in a short-lived period of relative prosperity.
   A major consequence of the real estate collapse after 2006 was the closing of access to home equity through cheap refinancing, which in turn crimped consumer spending and sent ripples through the entire economy.

   Effects

4. Refinancing can either make a loan cheaper or more costly. For refinancing to make sense, either the credit rating of the borrower should have improved or interest rates should have declined. In either case, the borrower can pay off a new loan faster without increasing their monthly payments. On the other hand, monthly payments can sometimes be decreased by greatly extending the period of a loan, but this will usually make the total cost of the loan greater.

   Considerations

5. While using refinancing to get at equity seems like free, cheap money, in reality, it amounts to spending one's savings. Cars are less frequently refinanced because the terms of auto loans are much shorter, the principal is much lower, and a car is easy to repossess.
   Homes are more difficult to possess and resell, and can store a vast amount of wealth, so lenders are more willing to refinance. Borrowers should resist using home equity as cheap credit, however, and consider the full ramifications before refinancing.

6 Reasons why you should refinance

If you're thinking "Should I refinance my house?", check out the 6 reasons as to why you may take such a decision.

• You want to save more:
  Your monthly payments will be reduced if you get a low rate or when your loan term is extended. However, with an extended term, your monthly savings will increase but you'll be paying more in total interest for the life of the loan.
  
• You want to pay down your mortgage quickly:
  You can shorten the length of your mortgage by reducing the loan term. Monthly payments will no doubt go up, but you will be able to save more in the overall interest payment. Moreover, you'll be debt free in a shorter time.
  
• You need extra cash to pay off credit cards:
  If you have enough home equity, you can borrow more than the current loan balance. With the extra cash, you can pay off high interest debts such as credit card balances or installment loans. You gain out of it as the interest on such debt is not deductible unlike mortgage interest.
  
• You wish to consolidate 2 loans into one:
  If there's enough equity (due to high appreciation), you can consolidate first and 2nd mortgages and refinance into a single first mortgage. The monthly payment on the new loan is likely to be lower than the combined payments on the first loan and the second mortgage.
  
• You want to convert an ARM into FRM:
  This allows you to lock in at a low rate. You can thus repay the loan with stable monthly payments rather than variable payments over the loan term.
  
• You want to get rid off PMI:
  If your current loan balance is below 80% of the new appraised home value, you can go for a home refinance and stop paying the PMI.

Tips on when to refinance a mortgage

"Should I refinance my house now?" – This is what most people ask when they're willing to reduce their mortgage payments by taking advantage of low rates. To find the answer, check out the mortgage refinance tips given below.

• Build up equity:
  It is feasible to go for a refinance when you have built up at least 10% equity in your home (For Fannie Mae owned mortgages, the value is 5%). It is also possible for you to choose the option if your equity is less than 5%, but you may have to pay a certain amount of cash in order to make up for the difference in equity.
  
• Check if mortgage refinance rates are low:
  It's better to follow the 2% Rule which suggests that you can enjoy the benefits of a home refinance if your mortgage refinance rate is 2% lower than that on your current loan. The interest savings will help you recoup the costs you've paid for the new loan provided you stay in the property for a certain period of time (break-even period). However, there are no-cost as well as low-cost refinance loans wherein the costs are included into the loan. But you can expect comparatively higher rates on such loans. Moreover, these loans are limited when the market is in a credit crunch. Know more about when to refinance rule of thumb.
  
  It is advisable that you compare mortgage refinance rates offered by different lenders in order to find the best rate that you can afford. This will help you save more in interest over the life of the loan.
  
• Pay off any late payment:
  There is no such limit on the number of times you can go for home refinance loans. Most lenders prefer that you have no late payment for the past 12 months before you switch over to a new loan.
  
• Remove negatives and improve credit score:
  Pull your credit report from the bureaus and review it for any negative items (late pays, collections etc) and inaccurate detail. Try to dispute negative items and remove them from the report. If required pay off any unpaid debt. Otherwise, you won't get a low rate and may not even qualify. Of course there are lenders in the subprime market who may offer you a bad credit refinance loan, but it's better to avoid them as they'll possible charge higher rates and fees.,
  

Author: Jessica Bennet Community Mentor