Refinancing a Mortgage

Refinancing is when you replace the existing mortgage on your home with a new one. The old mortgage is paid off with the proceeds from the new one and you are left with the new mortgage. Why would you want to do this? The main reason is to get a mortgage with more favorable terms.

For example, perhaps interest rates have dropped significantly since buying a house and obtaining your mortgage. Or maybe your credit record wasn't the best when you obtained your mortgage, so you had to pay a higher interest rate to get the mortgage. Maybe the amount you had for a down payment was very small or nonexistent, and you had to pay a higher interest rate to obtain close to 100 percent financing.

When interest rates drop, some homeowners replace a conventional 30-year mortgage with a 15-year mortgage because the monthly payment will be comparable and paying the mortgage off in 15 years saves a considerable amount of interest in the long run. Or you may have a balloon mortgage coming due, and you want to get a mortgage that enables you make monthly payments again. Whatever the reason you're considering refinancing, there are several things you should keep in mind.

The refinancing process. Refinancing is basically like applying for a mortgage all over again, just as you did when you bought your home. The same types of lenders that you may have considered for a mortgage are the ones you will be looking to now for refinancing purposes. This means you'll have to go through application procedures, home appraisals, and will be likely to incur closing fees as well.

Also, if you have a pre-payment penalty clause in your present mortgage, you will have to pay that penalty as well if you refinance. Therefore, you must make certain that it's actually worth it for you to refinance.

Tip Your closing costs may be lower if you use the same lender for refinancing as you did for your present mortgage. Sometimes fees, such as pre-payment penalties, may even be waived. However, don't let lower fees unduly influence you to stay with your present lender. Always look at the overall package a lender offers.

A rule of thumb is that your new loan should have an interest rate that is at least 1 percent less than your present mortgage before you consider refinancing. Also, you must plan on owning your home for a long enough period--generally five years is required--to at least breakeven when it comes to the costs and fees incurred in obtaining a lower interest rate. These rules are not set in stone though, so your best bet is to use the calculators below and actually plug in the numbers you're working with to determine the financial result of your refinancing.

Planning Note The points you pay for refinancing should be a major consideration in your choice of a new loan. This is because unlike points paid out-of-pocket for your original mortgage, points paid for refinancing are not deductible outright for income tax purposes, whether you use loan proceeds or pay them yourself. You must amortize refinancing points over the life of your mortgage (usually 15 or 30 years). However, points on a refinancing loan are fully deductible in any year in which the loan is totally repaid. Keep this in mind if you refinance more than once over the course of owning a home. It may be a financially better decision to pay a bit more in interest (by more we mean perhaps .25 or .5 percent) rather than pay points for a loan with a lower interest rate. Of course, you should diligently shop around for a low interest rate mortgage with no points. This type of ideal situation is available particularly if your credit rating is excellent, because the refinancing business competition is fierce, particularly for the homeowners with good credit histories.

Once you've done the calculations, you should be able to decide the circumstances that make refinancing the right step for you.

Financial Calculators Use this Should I Refinance Calculator to determine how much interest you can save if you refinance your mortgage. Click the report button and get full details about your results. Use this Mortgage Refinance Breakeven Calculator to help you decide whether you should refinance by showing you how long it will take before you break even on a mortgage refinance. Click the report button and get full details about your results.