Refinancing — What Is It and How Do I Do It?

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Perhaps your existing loan may be too expensive, and you would like to improve it in some way. Or maybe the economic climate has changed, and it has become tougher than expected to make mortgage payments. A new loan could be beneficial if it has better features or terms to improve your finances. This situation calls for refinancing, which may help to reduce your monthly payments or lower your interest rates.

What is Refinancing?

Refinancing is the process of replacing an existing loan with a new loan or getting a new mortgage to replace the original. The new loan could pay off your existing debt completely. Apart from that, there are some other advantages of refinancing:

Lower interest rate
Lower interest rate translates to lower monthly payments, which allows you to enjoy easier cash flow management and more cash in your budget to spend every month or put the cash towards various investments. You could even reap significant interest savings by refinancing if you are currently on a long-term loan. However, take into consideration that there would most likely be a tradeoff. You might have to extend the duration of time to repay the new loan. Since the new loan offers a lower interest rate and lower monthly payments, you might find yourself paying more as the life of the loan is extended.

Shorter loan duration

There are loans which allow a homeowner to refinance down from a longer loan term to a shorter one such as from a 30-year loan to a 15-year loan instead. While the monthly payments may increase, it allows you as a homeowner to save on interests and pay off the home earlier, so that you may own the home into retirement. Other circumstances when a homeowner would like to shorten his loan duration may be due to the fact that he has paid off his other loans, inherited a sum of money or received a bonus at work.

Change loan type
Certain loan types may suit you more than others. For example, you might have an existing variable-rate loan, but you would prefer to switch to a loan with a fixed rate. Switching to a fixed rate loan would protect you from uncertainties. Some mortgages can be unpredictable and may increase without warning, leading to fluctuations which lead to you having to pay a couple hundred or thousand dollars more each month. A fixed rate mortgage would instead offer you greater stability. Examples of commonly fixed rate mortgages include 30-year and 15-year loans.

Pay off a loan that’s due
Perhaps you might not have sufficient funds to pay off an upcoming loan that’s due soon. A way to deal with this situation might be to refinance the loan with the aid of a new loan. A caveat is that you might have to take more time to pay off the debt completely.

Debt Consolidation
There are numerous benefits of debt consolidation. One of which is allowing you to utilize the equity to pay off credit card bills and attain a higher credit score, which may further allow you to take advantage of the improved credit to switch to a loan with lower interest rates and lower payments. In addition, debt consolidation also allows you to utilize the equity to spend it on other investments, make improvements to your home or send your kids to college.

How do you do it?
Refinancing is a big decision. It is important to have a clear understanding of your financial situation and objectives before you decide to refinance. Refinancing can be beneficial if it’s done right. However, without the right knowledge, it can harm you financially instead, when the interest rates of your loan rise. The first step would be to tap into a refinance calculator and figure out if you’ll save by refinancing.

A refinance calculator will utilize your financial information and determine if refinancing would suit you. You can also determine how your monthly payment would adjust accordingly, along with how much you are expected to pay in closing costs.

Be aware of certain situations especially when the closing costs are high, as it may take you longer to recover the costs than staying on your current loan program.