People do home loan refinancing for a variety of reasons, from getting a lower interest rate to "cashing out" some of the equity in their home for purchases.
The process for going through home loan refinancing is very similar to applying for a first mortgage. The mortgage lender or broker will require you to fill out an initial application, agree to a credit check, and have your home appraised. The closing process is also similar, with most of the same forms to be filled out.
Another similarity between purchasing and refinancing is that you'll be presented with options for various types of mortgages: fixed rate mortgages, adjustable rate mortgages, reverse mortgages, and so on.
When should you think about home loan refinancing? Most experts agree that, if you're trying to get a lower mortgage rate, you should only refinance when you can get a rate that's at least one to two points below the rate you have now. The reason is that anything less than one percentage point will not save you enough in monthly payments to justfiy the costs of refinancing. To get an idea of how long it would take you to break even on the refinancing costs, check out our Mortgage Refinancing Calculator.
Most mortgage lenders and brokers today will allow you to roll the closing costs of your home loan refinance into the total amount being refinanced. While this makes the refinancing easier if cash is tight for you, it also means that you'll be paying for those closing costs over the entire term of your mortgage. So, let's say your total closing costs are $1800. If you get a 30 year loan at 6%, that $1800 will actually cost you $3884 over the term of your loan.
One factor to take into consideration when deciding whether to refinance is the amount of interest you're currently paying on your mortgage each month. At the outset of a mortgage, the majority of your monthly payment is applied to interest, and only a small portion of your payment is applied to your principal balance.
As you continue to make your monthly payments, the amount of your payment applied to the principal balance increases, and the amount going toward interest decreases.
So, when you're ten years into a 30 year mortgage, you're paying down the principal balance much faster than you were in the first year.
When you do a home loan refinancing, you're starting all over again. The majority of your monthly payment will be applied to interest.
That's why it's important for you to consider whether refinancing is right for you.
As mentioned above, many people refinance their home loans to "cash out" some of the equity in their homes for purchases. While this may make sense if you're using the cash to make improvements to your home because you plan to sell it soon, using your home's equity for other types of purchases doesn't usually make sense.
For example, let's say that you're refinancing your home loan in order to buy a $20,000 car. If your new interest rate is 6%, and the term of your new loan is 30 years, that $20,000 car will cost you $43,168!
So, in general, you're much better off taking out a shorter-term loan for things like cars, new windows for your home, and so on.
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