When you refinance your house, the new loan pays off the existing loan.
The most obvious advantage of refinancing is helping financially strained borrowers to use some of the money from their home’s value to cater to other needs. This is especially helpful when you’re anticipating an increase in your budget.
Other benefits include shortening the term of your mortgage, lowering the interest rate, and in some cases, skipping a mortgage payment while the lender is processing the new loan.
However, refinancing also comes with downsides particularly when you don’t understand what you’re signing up for. Before you decide to go ahead with it, here are the questions you need to ask yourself and the do’s and don’ts that’ll save you from financial pitfalls.
You can avoid unforeseen money issues if you’re careful enough to put yourself on a scale and see whether refinancing your house is a plausible option. Consider the following questions:
Lower interest rates shouldn’t be the only reason you jump on a refinancing loan. However, it could work if all you want is lower interest rates and reduce your monthly repayments.
According to calculations made by CNBC using the HSH.com calculator, a person servicing a 30-year long mortgage worth $250,000 will have a monthly payment of $1,260.78. This monthly figure drops to $1,147.37 when they refinance. Additionally, they get to save over $34,000 in interest over the thirty-year term.
Alternatively, you could choose to refinance to shorten the term of your loan. It’ll halve the interest rate but your monthly payment will inevitably go up. Also, if you’ve overestimated your ability to pay more for a shorter term, you’ll end up in trouble.
In case your goal is to deal with the uncertainties of an adjustable-rate mortgage, lower interest rates offered by refinancing will work for you.
According to Investopedia, closing costs generally range between 3 and 6 percent of the purchase price of a home. As an example, if you purchase a $200,000 home, your closing costs could fall between $6,000 and $12,000.
Say your closing costs amount to $3,000 and you get to save $200 monthly by refinancing. It will take 15 months to break even. If you live in the house longer, the refinancing will be worth it.
On the contrary, if you aren’t able to save much -say you only save $50 – it will take you four times as much time to break even. Refinancing would not be very plausible in this case.
Closing costs are also different based on the state, loan type, and lender, so ensure you understand how these costs apply in your situation.
Just to be clear, there’s no such thing as no-cost refinancing –in other words, zero closing costs. You end up paying for it one way or another.
The best way to go about closing costs is to ensure you can afford them and to settle them upfront. You could also choose to have them included in your loan if you’re not worried about increasing your repayments.
The last option is to not pay for them upfront but pay higher interest rates –as high as half a percentage point.
The Personal Finances Do’s and Don’ts When Refinancing a House
Now that you know what questions to consider before committing to refinancing a house, here are the do’s and don’ts that’ll ensure you don’t go from the proverbial frying pan into the fire.
Thousands, if not millions of people have bitten more than they can chew with refinancing just because they didn’t understand how it works. If you’re seriously considering refinancing, it always pays to have as much knowledge about it as you can.
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