Deciding to Refinance a Mortgage

Deciding to refinance a mortgage should include many considerations beyond the drop in interest rates. Examine all the options before making this major financial decision.

Learn about different types of home loans.

Refinancing a mortgage pays off the existing mortgage and creates a new mortgage loan. This is different from a loan modification where the loan remains in place but the terms of the loan are changed. Instead, a refinance involves a new mortgage loan with new terms and can also be with a new lender altogether.

When you refinance a mortgage loan, the original mortgage loan is no longer valid. Your refinanced loan falls under the terms of the new agreement with the lender.

You should not decide to refinance a mortgage loan on a whim. This can be a potentially costly transaction, so it should not be entered into without some careful consideration first.

In order for a mortgage refinance to save you money, you need a significant drop in interest rates. While it is true that even a small drop in interest rates can save you quite a bit of money in the long term –especially when the amortization of the loan is as lengthy as 15 or 30 years- don't forget that a mortgage refinance is the creation of an entirely new mortgage loan and will therefore involve all the same closing costs that you paid when you obtained your first loan. While you may be able to avoid some of the closing costs because of the information you already have in your possession, such as a survey of the property, the lender will undoubtedly still insist upon a title search and other requirements that will add up in price quickly.

Look for an interest rate drop of at least 1%, but ideally 2% or more. In other words, if you currently have a mortgage loan interest rate of 7%, you should not even think about refinancing until the rate available to you has dropped to at least 6%, but ideally 5%.

If you plan on staying in the home for an extended period of time, a mortgage refinance at an opportune time can save you quite a bit of money in the long run. On the other hand, if you don't plan on staying in the home for more than a year or two, a refinance may cost you more money because of the closing costs that are involved.

If you are not sure about your intentions with regards to whether you will stay in your home or sell it in the next couple of years, refinancing may not be in your best interests right now.

Some homeowners look to mortgage refinancing as a way to consolidate debt or to get their hands on some cash using a low interest, potentially tax deductible loan. A cash-out mortgage refinance can be used for many purposes, including:

• Consolidate unsecured debt into the mortgage loan
• Combine a first and a second mortgage into one loan
• Obtain a lump sum of cash to use for whatever purpose

Whether this refinance option is open to you depends on several factors, but the main consideration lenders look at before approving a cash-out refinance is the amount of equity in your home. When making the decision whether or not to refinance a loan for consolidation purposes, look at the overall potential savings as well as any extra fees that may be included in the loan because of the cash-out feature.

A mortgage calculator on your lender's website may assist you in running the numbers to find out if this is a good option.

Refinancing a mortgage loan should be examined from all angles because it is not simply about lowering the interest rate. Look at the full financial picture before deciding to refinance a mortgage.

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