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Refinancing Your Loan

Mortgage Library: Refinancing Your Loan:

There are lots of reasons you might want to refinance. One of the main reasons homeowners refinance their mortgages is to take advantage of lower interest rates. If rates have lowered since the time of your original mortgage you may refinance your mortgage at a better rate and therefore reduce your monthly payments.

You may opt to refinance as a source of obtaining money at a low interest rate (for a major purchase or if you are just wanting to consolidate debt). See: Using Equity to Your Advantage.

If you are thinking about refinancing your mortgage, you might want to consider other types of mortgages. For example, you might want to look into a mortgage with a shorter term. If you currently have a 30-year fixed rate loan, you might consider refinancing to a 10-, 15-, or 20-year loan which will lower the total amount of interest you will pay over the life of the loan and will let you to pay off your loan faster.

You also might want to switch an adjustable rate mortgage with high or no limits on interest rate increases to a fixed rate mortgage which provides the predictability of knowing exactly what your mortgage payment will be for the life of the loan.

It is important to determine the best type of a new mortgage. The type of mortgage loan you select will depend on how long you expect to continue living in your current home and the amount of monthly payment you can comfortably afford.

If you don't plan to stay in your house for at least 5 to 7 years, it will be reasonable to consider an Adjustable Rate Mortgage, Balloon Mortgage or Two-Step Mortgage. An Adjustable Rate Mortgage traditionally offers lower interest rates during the early years of the loan than fixed-rate loans. A Two-Step Mortgage will give you a lower interest rate than a 30-year mortgage for the first five or seven years. A Balloon Mortgage offers lower interest rates for shorter term financing, usually five or seven years.

You can start to consider 15- or 30-year fixed rate mortgages if you plan to stay in your home for more than seven years.

The refinancing process will remind you of what you went through in obtaining the original mortgage. In reality, refinancing a mortgage is simply taking out a new mortgage. You will encounter many of the same procedures and the same types of costs the second time around.

To figure out whether it pays to refinance, you must calculate the total refinancing costs and answer the question that may help you decide: How many months will it take to break-even? You should consider refinancing if you plan to stay in your home for more than the time it takes to break-even.

Here's an example. If the total refinancing costs are $2,000, and your monthly savings on the new loan are $100, it will take you 2000/100=20 months to break-even. If you don't plan on staying in the house that long, it won't pay to refinance.

A general rule states that if rates drop by two percentage points, that was the time to refinance. However, it could pay off to refinance with only a one percent lower rate if you find a good deal on refinancing costs. New lender may be willing to negotiate a reduction of points or a waiver of the title search, application, credit check, or other fees.

You can refinance with no points and no fees whatever. Some lenders offer a zero point/zero fee loan which means that you do not have to pay most of the fees generally required, however, your monthly payments may be somewhat higher (lenders generally will charge a higher interest rate for this type of loan). The zero point/zero fee loan eliminates the need to do a break-even analysis since there is no upfront expense that needs to be recovered.

The greatest deterrent to refinancing could be a prepayment penalty on your present mortgage. The practice of charging money for an early pay-off of the existing mortgage loan varies by state, type of lender, and type of loan. Laws in many states prohibit or limit mortgage prepayment penalties. The mortgage documents for your existing loan will state if there is a penalty for prepayment.

Prepayment penalty on your mortgage (if any) should be added to the total refinancing costs when you do a break-even analysis. Example:

Refinancing costs: $2,000
Prepayment penalty: $1,500
Total of all fees on your new mortgage: $2,000+1,500=3,500
Monthly savings: $100
It will take you 3,500/100=35 month to break-even.

Once you have decided to refinance you should shop for a rate similarly you do when getting your first mortgage. Your existing lender may not have the best rates and programs. But bear in mind that the existing lender may waive the appraisal, title-search, and possibly credit report fees and there's a good chance that you'll get a better interest rate.

Related Articles:

Types of Mortgage Loans Review characteristics of all the basic loan programs available today.
Using Equity to Your Advantage
Shopping For a Mortgage Information that will help you shop for a mortgage most effectively.


Am I better off refinancing? The calculator allows you to decide whether or not to refinance taking into account different factors.
What will my refinancing costs be? An estimate of the closing costs you might pay when refinancing.

Government Publications:

Refinancing Your Home (FTC) The publication contains useful information to help you decide whether to refinance your home mortgage and how to go about doing it.
A Consumer's Guide to Mortgage  Refinancings (The Federal Reserve Board and the Office of Thrift Supervision) The information contained in this government publication is intended to help you ask the right questions when considering refinancing your loan.

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