Commercials advertising home loan refinances have become increasingly common. Consumers are often confused about whether refinancing is a good or bad idea. Refinancing your existing mortgage can be either a good or bad decision, depending on your specific situation.
Identification
Refinancing means replacing the existing mortgage that you have with a new mortgage, which has different terms. Refinancing a mortgage can be a long and expensive process. According to the financial website, Investopedia, the cost of refinancing is usually between 3 to 6 percent of the new loan's principal. This cost may be worth it to homeowners, because they may get a better interest rate, a better type of mortgage or a better repayment period.
Lower Interest Rate
The most common reason for refinancing is to get a mortgage with a lower interest rate. Investopedia states that refinancing is worth the costs, if your interest rate can be reduced by at least 1 or 2 percent. If interest rates are lower than when you first purchased your home, refinancing can allow you to lock-in a lower interest rate, which can save you thousands of dollars in the long run. Interest rates have to be low for refinancing to be a good idea.
Affording Additional Costs
You should only refinance an existing mortgage if you are able to afford all of the costs associated with the refinance. Too often, people refinance because interest rates are low, but they fail to realize that they will have to pay all of the same closing costs that they paid with the first loan, over again. These additional costs include loan origination fees and potentially several thousand dollars in points. If the original loan has a prepayment penalty, there might also be additional costs in the form of penalties to consider. The real estate website Rebuild states that if you plan to stay in the home for a long time, and know that a lower interest rate will save you more money than the upfront costs will be, then it is a good idea to refinance.
Switching to a Fixed Rate
Another good reason to refinance is to switch from an adjustable rate mortgage, also called an ARM, to a fixed rate mortgage. This may or may not save you money but it will provide you and your family with more security. Adjustable rate mortgages can increase at any stated time and can increase your monthly payment drastically. If you aren't ready to make higher monthly payments, and you would rather be able to budget what your exact payment will be each month, refinancing into a fixed-interest rate loan is a good idea.
Consolidating Debt
A final reason to refinance is to consolidate debt. Investopedia states that homeowners sometimes refinance in order to replace some of the high interest debt they have with a low interest mortgage loan. This is only a good idea if your family budgets well and you know that you will be financially savvy enough to not fall into debt again.
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