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The most common reason for
refinancing is to save money. Saving money through
refinancing can be achieved in two ways:
-
By
obtaining a lower interest rate that causes one's monthly
mortgage payment to be reduced.
-
By
reducing the term of the loan, thus saving money over the
life of the loan. For example, refinancing from a 30-year
loan to a 15-year loan might result in higher monthly
payments, but the total of the payments made during the life
of the loan can be reduced significantly.
People also refinance to convert
their adjustable loan to a fixed loan. The main reason
behind this type of refinance is to obtain the stability and the
security of a fixed loan. Fixed loans are very popular when
interest rates are low, whereas adjustable loans tend to be more
popular when rates are higher. When rates are low, homeowners
refinance to lock in low rates. When rates are high, homeowners
prefer adjustable loans to obtain lower payments.
A third reason why homeowners
refinance is to consolidate debts and replace high-interest
loans with a low-rate mortgage. The loans being consolidated may
include second mortgages, credit lines, student loans, credit
cards, etc. In many cases, debt consolidation results in tax
savings, since consumers loans are not tax deductible, while a
mortgage loan is tax deductible.
The answer to the question
"Should I refinance?" is a complex one, since every
situation is different and no two homeowners are in the exact
same situation. Even the conventional wisdom of refinancing only
when you can save 2% on your mortgage is not really true. If you
are refinancing to save money on your monthly payments, the
following calculation is more appropriate than the rule of 2%:
-
Calculate
the total cost of the refinance––example: $2,000
-
Calculate
the monthly savings––example: $100/month
-
Divide
the result in 1 by the result in 2––in this case
2000/100 = 20 months. This shows the break-even time. If you
plan to live in the house for longer than this period of
time, it makes sense to refinance.
Sometimes, you do not have a
choice––you are forced to refinance. This happens when you
have a loan with a balloon provision, but with no conversion
option. In this case it is best to refinance a few months before
the balloon comes due.
Whatever
you choose to do, consulting with a seasoned mortgage
professional can often save you time and money. Make a few phone
calls, check out a few web sites, crunch on a few calculators
and spend some time to understand the options available to you.
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