You can’t turn on your television or fire up a browser without seeing some sort of advertisement for a low cost mortgage loan as an alternative to whatever you’re currently paying for your home. The question is, however, is refinancing a good idea and does it always make sense? Or, is it simply better to keep your current mortgage loan in place?
What’s Involved?
First things first… what exactly does it mean to refinance your home loan? Refinancing simply means you’re taking out a new loan that will pay off your existing loan. You’re not changing the terms of your current mortgage but are instead paying it off with a new loan that has new terms. You can certainly refinance with your current lender or you can refinance your home loan with an entirely different lender. It’s completely up to you.
The process is relatively simple. As you did for your current loan, you’ll visit a mortgage broker or a mortgage lender who will ask some basic questions about your credit and financial situation and then attempt to get you qualified or “pre-qualified” for a new loan. The new loan, however, would be subject to the normal underwriting procedures that include an appraisal of your property, a credit check and an approve/deny decision by an underwriter. This process can take a few weeks or longer.
Pros And Cons
There are really only two benefits to refinancing; paying less interest and shortening the length of your loan. If you’re able to refinance into a loan that results in a reduction of your interest rate to something lower, then you’ve normally made a good decision. But, you’ll have to balance the lower monthly payment with the cost to refinance, which can cost thousands of dollars in many cases. So, if your monthly savings will eventually surpass the amount you paid to refinance (and pretty quickly…as in less than a couple of years) then you’ve likely made a good choice. The faster you can recoup your cost to refinance thanks to a lower monthly payment the better deal you got.
The second and certainly less discussed benefit is reducing the amortization period of your loan. When most people refinance they replace a 30-year fixed rate mortgage with another 30-year fixed rate mortgage, which is fine except for the fact that you’ve just started over from scratch and now have 360 payments, again, before your loan is paid off. And while you can certainly make a larger payment each month in an effort to pay off the loan faster, it’s certainly not something that’s done commonly.
If you can make the monthly payment work then refinancing out of a 30-year mortgage to a 15 or 20-year mortgage may make more sense. Your monthly payment will be higher but you’ll be paying off the loan faster. You may have heard the saying that with a 30-year mortgage it takes a few years before you “own the doorknobs.” That’s certainly true because the first several years of your loan you’re paying mostly interest and the actual balance of your loan isn’t moving down much.
A 20-year loan and especially a 15-year loan will allow you to see larger chunks of the balance actually paid off much faster than with a 30-year loan. Even after a few years you’ll see a considerable reduction in the amount you owe. And I can speak from experience that it feels really good to see that balance go down quickly.
But perhaps the most gratifying thing about a shorter loan is the considerably lower amount of interest you’ll pay over the life of the loan. Of course the savings can vary based on the amount of the mortgage but you can save tens of thousands of dollars, or more, by shortening your payback period. The challenge with the shorter payback period is, again, the larger monthly payment and if something goes wrong with your job or family income then you don’t have flexibility to pay less, like you would if you just stick with a longer term 30-year mortgage. Choices choices!!
