An Introduction to Refinancing

Refinancing can get very confusing. It is easy to become overwhelmed by the large number of available options. However, a little education can make the process far less intimidating. This article will discuss some of the options for those interested in refinancing and some of the factors to consider when deciding if refinancing is a wise decision in your situation.

Consider the Options

There are many options for homeowners who are considering refinancing. The most important decision may be the type of loan. Fixed rate mortgages and adjustable rate mortgages (ARMs) are the two main types of mortgages that homeowners will likely encounter. There are also hybrid loan options available.

A fixed rate mortgage is one in which the interest rate remains constant throughout the loan period. This is especially favorable when the homeowner has a credit score which is good enough to lock in a low interest rate.

ARMs are mortgages where the interest rate varies over time. The interest rate is usually tied to an index such as the prime index. This is a riskier type of loan.

Although ARMs are considered riskier, there is usually a certain degree of protection written into the loan agreement. This may come in the form of a clause which limits the amount the interest rate can increase over a fixed period of time. This can provide some protection from sharp increases in the interest rates and correspondingly unmanageable mortgage payments.

Hybrid loans combine a fixed element with an adjustable element. An example is where the lender may offer a fixed interest rate for the first five years and a variable interest rate for the remainder of the loan. Lenders will sometimes offer a lower introductory interest rate for the fixed period to make the mortgage appear more desirable.

Consider the Closing Costs

The closing costs associated with refinancing should be carefully considered. This is important because when homeowners refinance their home they often pay many of the same fees they paid when they first purchased the home. These costs may include appraisal fees, application fees, loan origination fees and a many other expenses. These costs can become substantial and may make some refinancing options untenable.

Consider the Overall Savings

When deciding whether to refinance, the overall savings should be carefully considered. Although some homeowners refinance to simply lower their monthly expenses, most homeowners consider the amount of money saved over time from refinancing to be the primary concern.

The amount of money the homeowner will save is largely dependent on the new interest rate compared to the old interest rate. Other important factors are the remaining balance of the existing loan and the amount of time the homeowner plans on staying in the house before selling the property. It's good to remember that the amount of money saved by negotiating a lower interest rate is not the whole story. The homeowner must also subtract the closing costs and consider how a potential refinancing will affect his overall monetary situation and financial goals.

When Could Refinancing be a Mistake?

Some homeowners mistakenly think that refinancing is always a viable option. This is a dangerous way of thinking and can result in serious financial problems if you choose the wrong time to refinance.

Refinancing can be a mistake when the homeowner does not stay in the property long enough to recoup the refinancing costs. Refinancing can also be a poor choice when the homeowner has had a credit score that has dropped since the original loan. Another example is when the interest rate has not dropped enough to offset the closing costs associated with refinancing.

Recouping the Closing Costs

In determining whether or not refinancing is worthwhile the homeowner should determine how long he would have to hold on to the property to recoup the closing costs. This is an important concern especially in the case when the homeowner intends to sell the property in the near future. There are refinancing calculators that will let homeowners know the amount of time it will take to make refinancing worthwhile.

When Credit Scores Drop

Many homeowners view a drop in interest rates as a signal that it is time to refinance. However, when these interest rates are accompanied by a lower credit score, the refinanced mortgage might not be favorable. It is wise to take advantage of free refinancing quotes to get an idea of whether it will be beneficial to refinance, especially if you now have a lower credit score.

Have the Interest Rates Dropped Enough?

Another common mistake is to refinance whenever there is a significant drop in interest rates. The homeowner should first carefully evaluate whether or not the interest rate has dropped enough to make refinancing worthwhile, after closing costs including application fees, origination fees, appraisal fees and a variety of other costs. These costs can add up very quickly and may negate the benefits of the lower interest rate.

Refinancing Can Be Beneficial Even When It Would Normally be a Mistake

Refinancing is not always the ideal solution, but some homeowners might still choose refinancing even when it is technically a mistake to do so. A common example of this type of situation is when a homeowner refinances to get lower interest rates even though the homeowner winds up paying more in the long term. This can occur when interest rates drop, but not enough to result in an overall savings or when a homeowner consolidates short term debt into a long term mortgage refinance. Although most financial advisors would warn against this approach, a person may occasionally have legitimate reasons for increasing their monthly cash flow by reducing their mortgage payments. Just be sure to do the appropriate research and weigh the consequences befor refinancing.