Refinancing: Why, When and How

Planning & Saving
on April 12, 2012

It may seem like less of a hassle to keep writing out the same mortgage check month after month. However, there may be a time when refinancing to secure a better interest rate and lower monthly payments may be more financially beneficial to you.

Why refinance? Refinancing means paying off your existing mortgage and establishing a new one. According to the Federal Reserve Board, a primary mortgage and second mortgage can be merged into new loan as well. Why refinance, though? Refinancing can lower the interest rate of your mortgage, which may help your home equity build faster. It also can lower your monthly mortgage payments and/or help stabilize your monthly payment when you acquire a fixed-rate loan.

When to refinance? The best time to refinance varies depending on the individual and his or her circumstances. If you can reduce your interest rate at least 1 percent or more, it may be a good time to refinance. For some homeowners, refinancing gains lower monthly payments, freeing up cash that can be used for investments such as college or retirement funds or cash to pay off credit card debt.

Is there a time not to refinance? If you plan to sell your home in a year or less, refinancing may not be financially beneficial. For example, if your monthly payments are reduced by $150 but the closing costs total $3,000, it will take 20 months to make back the fees. When your job is not secure, refinancing may not be a good idea, either. The cash you’d use to cover the fees could be cash you need for living expenses if you found yourself out of work. The Federal Reserve says reconsider refinancing if your current mortgage has a prepayment penalty fee. Check with your lender if there is a fee, and if there is, ask if it can be waived so you can refinance.

How does a refinance work? After you have selected a lender, the lender assesses your current mortgage and the amount you want to borrow for the new mortgage, plus your income, assets and debts. The current value of the property will be assessed through an appraisal. A credit check is run as well. A lower credit score can affect the interest rate offered. Once a loan interest rate is agreed upon, lock it in. Usually, the refinancing process takes about 45 days, but it can take longer. Locking in the rate protects you from any upward swings in the interest rates.

What fees are charged? Typical refinancing fees include lender and appraiser fees, title insurance, recording fees and a charge for a credit report check. A fee is issued by the attorney or title company at the closing as well. Sometimes a lender will negotiate certain fees such as credit report checks. Always ask if you are eligible for any discounts or fee waivers.

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