What is Refinancing
What is refinancing? Learn about how does refinancing work and the crucial questions to ask when refinancing – do not make a refinancing decision without first reading through this carefully.
How does refinancing work
Refinancing means to replace the current mortgage on your house or your student/car/other loans with another mortgage of a different size and duration. More often than not, refinancing is profitable when original interest rates were high; you can then refinance to take advantage of lower rates. Refinancing thus allows for lower monthly mortgage payments.
Explain refinancing a mortgage
What is refinancing (mortgages): For mortgages, if you had a variable or adjustable rate mortgage, converting to a fixed-rate mortgage would be an excellent idea when interest rates are low. Refinancing a mortgage allows you to change several variables: your monthly payment, the length of your loan and the type of interest rate (fixed or variable).
Generally, you should look to shorten the length of your loan as far as possible (possibly converting from a 30-year mortgage to a 15-year mortgage) while maintaining an affordable monthly payment.
Questions to ask when refinancing
What are the questions to ask when refinancing? Answer these refinancing questions, and you will soon learn how does refinancing work:
- How much do you save monthly if you refinance? – Take your current monthly mortgage/loan payment and subtract it from your new monthly mortgage/loan payment if you refinance
- How long does it take to recoup the costs of refinancing? – Divide your closing costs by your monthly savings. This figure reflects the number of months it takes for you to break even.
Once you have the above two figures, ask yourself: do you intend to stay in your home for more than the number of months it takes to break even? If yes, refinancing will be a good move. Otherwise, you should look into other options, such as obtaining an equity line of credit.
One of the most important questions to ask when refinancing is this: does the length of your loan increase? When you refinance, you could get better interest rates and lower monthly payments, but sometimes this can be at the cost of adding to the length of your loan. Generally, the longer your loan, the more interest you pay over time: your refinanced mortgage might end up being even more expensive than your original mortgage loan!
Thus, you should limit your savings in monthly payments to the point where you would take the same or less time to pay off your loan. For example, if you would take 36 more months to pay off your loan on your original loan, you should maintain your loan length to at most 36 months. With better interest rates, your monthly payments will still be lower.