Refinancing

WHAT IS REFINANCING ?

Refinancing a mortgage means paying off an existing loan and replacing it with a new one. There are many reasons why homeowners refinance: the opportunity to obtain a lower interest rate; the chance to shorten the term of their mortgage; the desire to convert from a variable rate to a fixed-rate mortgage, or vice versa; the opportunity to tap a home’s equity in order to finance a large purchase; and the desire to consolidate debt.

SECURING A LOWER INTEREST RATE

One of the best reasons to refinance is to lower the interest rate on your existing loan. Historically, the rule of thumb was that it was worth the money to refinance if you could reduce your interest rate by at least 2%. Today, many lenders say 1% savings is enough of an incentive to refinance.

Reducing your interest rate not only helps you save money, it also increases the rate at which you build equity in your home, and it can decrease the size of your monthly payment

SHORTENING THE LOAN’S TERM

When interest rates fall, homeowners often have the opportunity to refinance an existing loan for another loan that, without much change in the monthly payment, has a significantly shorter term.

CONVERTING BETWEEN VARIABLE-RATE AND FIXED-RATE MORTGAGES

While variable rates often start out offering lower rates than fixed-rate mortgages, periodic adjustments often result in rate increases that are higher than the rate available through a fixed-rate mortgage. When this occurs, converting to a fixed-rate mortgage results in a lower interest rate and eliminates concern over future interest rate hikes.

Conversely, converting from a fixed-rate loan to a variable rate can also be a sound financial strategy, particularly in a falling interest rate environment. If rates continue to fall, the periodic rate adjustments on a variable rate result in decreasing rates and smaller monthly mortgage payments, eliminating the need to refinance every time rates drop.With mortgage interest rates rising, on the other hand, as they have begun to do, this would be an unwise strategy.

Converting to a variable rate, which often has a lower monthly payment than a fixed-term mortgage, may be a good idea for homeowners who don’t plan to stay in their home for more than a few years. If interest rates are falling, these homeowners can reduce their loan’s interest rate and monthly payment, but they won’t have to worry about interest rates rising in the future.

TAPPING EQUITY AND CONSOLIDATING DEBT

While the previously mentioned reasons to refinance are all financially sound, mortgage refinancing can be a slippery slope to never-ending debt. It’s important to keep this in mind when considering refinancing for the purpose of tapping into home equity or consolidating debt.

Homeowners often access the equity in their homes to cover major expenses, such as the costs of home remodeling or a child’s college education. These homeowners may justify such refinancing by pointing out that remodeling adds value to the home or that the interest rate on the mortgage loan is less than the rate on money borrowed from another source.

Many homeowners refinance to consolidate their debt. At face value, replacing high-interest debt with a low-interest mortgage is a good idea. Unfortunately, refinancing does not bring with it an automatic dose of financial prudence. Take this step only if you are convinced you’ll be able to resist the temptation to spend once the refinancing gets you out from under debt. Be aware that a large percentage of people who once generated high-interest debt on credit cards, cars and other purchases will simply do it again after the mortgage refinancing gives them the available credit to do so. This creates an instant quadruple loss composed of wasted fees on the refinancing, lost equity in the house, additional years of increased interest payments on the new mortgage and the return of high-interest debt once the credit cards are maxed out again – the possible result is an endless perpetuation of the debt cycle and eventual bankruptcy.

THE BOTTOM LINE

Refinancing can be a great financial move if it reduces your mortgage payment, shortens the term of your loan or helps you build equity more quickly. When used carefully, it can also be a valuable tool in getting debt under control. Before you refinance, take a careful look at your financial situation and ask yourself: How long do I plan to continue living in the house? And how much money will I save by refinancing?

THE RISKS OF REFINANCING

  • Lenders Mortgage Insurance

One of the risks of refinancing your home loan is that you may need to pay Lender’s Mortgage Insurance (LMI) to your new lender, even if you’ve already paid it. This is usually only true if you have a loan-to-value ratio (LVR) that is above 80 percent, which basically means you have less than 20% equity in your property. LMI can be expensive, so this may undercut the savings you receive from refinancing.

  • Fees

There may also be exit fees that you’ll have to pay out of pocket, too. These are fees that you may be charged for exiting out of your loan early and if you have a fixed rate home loan, these can be quite high. There may also be upfront fees for your new loan as well. In addition to exit fees there are also upfront fees charged by your new lender, such as application fees and valuation fees.

  • Longer loan duration

Refinancing may also lock you into your home for longer than you planned on staying. If you had hopes of moving soon, refinancing your home loan could hurt your efforts. If you move too soon the monthly savings you gained may not have been worth the overall cost of refinancing.

  • If you have a bad credit rating you might not get a good rate

Refinancing your home loan can also hurt you if you have bad credit history. If your credit history is less than stellar you may end up with a higher rate when you refinance. This isn’t in your best interest and can hurt your bottom line. A poor credit history can give you a higher interest rate instead of the lower rate that you were hoping for.

  • It could damage your credit history

If you have poor credit history and continue making applications to refinance you could damage your credit file further. This is because every application for credit is recorded on your file. Too many applications in one space of time could lead to denied loan applications, which further damage your credit file. Before refinancing it’s always a good idea to get a copy of your credit file.

  • More features could equal more fees

 Sometimes-hidden risk in refinancing comes in additional features that a lender may offer. A lender is always looking for business so they may try to persuade you to refinance by offering you features like a free credit card or an offset account. While these may sound like benefits, they could come with additional fees or tempt you to spend more. If your current home loan doesn’t have additional features it also might not have the additional fees. This will mean that while you’re possible saving in interest, you’ll be paying more money in fees.

Regardless of whether you’re thinking about refinancing to get a better interest rate or as a way to consolidate your debts, refinancing can be quite costly and may end up costing you more in the long run, so it pays to be informed.

Refinancing won’t suit every borrower, so by reading the list above you make the best decision when considering whether or not to make a switch. Talk to an informed broker at Jaira Home Loans who can take the guess work out and can provide you valuable options which could help in your decision making.