Refinancing

Refinancing is the process during which you can replace your current mortgage with a mortgage under new terms, either with the same or new lender. Since there needs to be a closing for every refinance, there are closing costs associated with this process. There are a variety of factors to consider while making the decision to refinance, such as the amount of years left in your current mortgage, the cost of refinancing, and the amount of documentation required for a bank to grant a new mortgage.

There are a number of reasons to refinance:

To lower your rate: If the current market rate is lower than the rate you are paying, you might want to consider refinancing. However, it is important to remember that lowering your rate isn’t always the same as lowering your payments. A lower rate may result in higher monthly payments over a shorter period of time (click here to read more about different amortization periods), which lowers the total amount of interest you pay.

To lower your monthly payments: On the other hand your primary goal may be to lower your monthly payments. Depending on how much of your loan is already repaid at the time of your refinance, your new mortgage may result in a higher overall sum paid to the bank. In order to simplify this overly-confusing scenario, we’re going to use Joe as an example; trusting readers can skip the next paragraph as the math does get a little intense.

Joe takes out a loan for $100,000 at 6% for 30 years. His monthly payments will be $600, and the total he will pay to the bank over these 30 years is $216,000. 10 years into his loan Joe’s wife loses her job and they realize they can no longer afford to pay $600 a month, so they decide to refinance in order to lower their monthly payments. At this point Joe has already paid $72,000, but his loan amount has only decreased to $81,000. Joe is able to lower his monthly payments to $435 a month on a loan for $81,000 at 5% for 30 years (this 30 year period begins at the time of refinance); however, the total he will now pay the bank over the next 30 years is $157,000. Together with the $72,000 Joe has already payed he will now pay the bank $229,000 (compared to the original $216,000) In this example Joe lowered his monthly payments but increased the total money he will end up paying to the bank.

To consolidate other debt: Any other type of debt, such as the money owed to credit card companies and car loans, are not tax deductible and are usually at higher interest rates. On the other hand, mortgage debt is typically less expensive and tax deductible. Money can therefore be borrowed against your house and used to pay off other types of debt. This is known as debt consolidation refinance.