Unlike a second mortgage or home equity loan, a refinance loan cancels your original mortgage and replaces it with a new one. There are many circumstances in which a refinance loan makes sense. However, it is not right for every situation. Provided here is a quick guide to refinancing your home.
Lowering Your Interest Payment
This is the most common reason for a refinance loan. If the interest rate on your original mortgage was high, you may want to refinance when the interest rate drops. You may also want to switch an adjustable rate mortgage to one with a fixed rate, particularly if your introductory period is about to expire.
However, refinancing for a lower interest rate will not always result in lower monthly payments. If you do not the up-front cash to pay closing costs, they may be able to be rolled into the new loan. This could actually result in your monthly payment going up rather than down.
Cash-out Loans
In some cases, you can get a refinance loan for more than the amount that is remaining on your mortgage. This will allow you to tap some of the equity in your home in a manner similar to that of a home equity loan. You will avoid paying for both your mortgage and the loan this way, but your payment will likely be higher than your original mortgage payment.
Disadvantages of a Refinance Loan
The major disadvantage of a refinance loan is that it will restart the clock on your mortgage. If you are fairly close to having your mortgage paid off and then elect to refinance, you may add additional years of payments.
Another disadvantage of a refinance loan is that it will count against your credit score as a major new loan. The more credit you have recently obtained, the less credit companies are inclined to provide. If you are in the market for a new car, vacation home or other major purchase, you may have trouble getting credit if you have just refinanced your home. However, if you have excellent credit, this will not greatly impact you.
The Bottom Line
A refinance loan makes great financial sense in many situations. If you need to tap the equity in your home, trade an adjustable rate mortgage for a fixed rate mortgage or lower your interest rate, refinancing your home may be the best option. If you are unable to pay closing costs up front, are close to paying off your mortgage or selling your home, or in the market for another major purchase, refinancing may not be your best option. Speak with a financial planner to determine the best course of action for you.
