Every year, hundreds of thousands of homeowners prepare to refinance their mortgages. In recent years, favorable financial conditions have led to an upsurge in this trend. While it's always advisable for homeowners to speak with financial professionals who have an intimate knowledge of their specific circumstances, it's certainly possible to generalize about the pros and cons of refinancing. If you're thinking about employing this method to reduce your monthly mortgage payments or free up much-needed capital, take a moment to learn more about it.
What is Refinancing?
Although it's occasionally referenced as "obtaining a second mortgage," "refinancing" is a common term that describes the process of restructuring an existing mortgage. In most cases, refinanced mortgages carry lower interest rates and longer payment terms. They may also include deferred-payment or balloon-payment features. Like any complex financial transaction, refinancing generally comes with a significant upfront cost that may reduce its efficacy for homeowners with short time horizons. For homeowners who plan on selling their homes within a few years, refinancing may not be a cost-effective strategy.
Prior to Refinancing
Prior to refinancing, a homeowner must assess his or her current financial situation. If he or she struggles to meet his or her monthly mortgage obligations and plans on remaining in the home for at least five years, this strategy may make sense. Likewise, a homeowner who carries a short-term mortgage that runs for seven to 15 years may find it suitable to extend his or her repayment window to 30 years and substantially reduce the mortgage's monthly payment in the process.
Assessing Goals, Risks and Interest Rates
Before a homeowner jumps into the refinancing process, he or she must also assess the likely outcome of the process. This involves establishing and adhering to pre-defined goals. For instance, a homeowner who wishes to set aside a college fund of $100,000 within a five-year period may need to refinance his or her home to make it happen.
Likewise, he or she must determine whether the associated interest rate reduction will be worth the time and expense that the process entails. Although mortgage rates have remained quite low since the financial crisis of the late 2000s, it's entirely possible that they'll rise significantly in the coming years. Depending on the size of the mortgage and the homeowner's payment-reduction goal, the refinancing process should result in an interest rate reduction of at least 1.5 percentage points.
When Does it Make Sense to Refinance?
A homeowner who wishes to refinance his or her home must have plans to stay put for at least five years. Many financial professionals argue that this "rule of thumb" should be extended to the seven-year mark. Additionally, the associated monthly payment reduction or repayment-window extension must be great enough to absorb the refinancing loan's closing costs. These costs typically amount to 1.5 percent to 2.5 percent of the loan's balance. In other words, the cost of refinancing a $200,000 loan may run from $3,000 to $5,000.
It's important to note that many industry experts advise homeowners against taking out multiple refinancing loans on a single mortgage. While homeowners who obtain high-interest mortgages may be inclined to refinance repeatedly as rates fall, this process can be time-consuming and stressful. It may also have an adverse impact on said homeowners' credit scores. As such, interested parties should wait for a clear-cut opportunity to pull the trigger on the refinancing process.
While refinancing is a powerful process that can have demonstrable financial benefits for a wide range of homeowners, it isn't suitable in all circumstances. Before you commit to a process that could have serious ramifications for your household's ability to procure credit or conduct major financial transactions, you should carefully assess your circumstances and refer to the guidance of an experience financial professional.*Image courtesy of freedigitalphotos.net