A mortgage refinancing is when a borrower replaces their existing mortgage with a brand new mortgage plan. In a refinance, a borrower takes out a new mortgage that is partly used to pay off the balance of their existing mortgage plan, the end result is usually a new mortgage with better terms for the borrower and a new balance amount.
The main reason borrowers refinance is to get more affordable terms for their mortgage. Refinancing can change the interest rate, period of the mortgage or consolidate multiple mortgage plans into one loan. Refinancing is especially popular during times when the interest rate in the market falls to lower rates.
Refinancing to Secure a Lower Interest Rate
Interest rates are the service charges of the lender which are paid off over time along with the mortgage. Interest rates are calculated as an annual percentage of the loan amount. As the borrower continues to make payments on the mortgage, a major part of the payment covers the interest rate while some of it goes towards the principal amount of the loan. This continues until almost halfway through the mortgage that the balance shifts. The majority of the payments start covering the principal amount instead of the interest.
What this highlights is the importance of having the best possible interest rate, because the higher it is the higher the total amount of the loan. This is where refinancing a mortgage can come in handy. By refinancing the mortgage, the borrower can replace their existing interest rate with a lower one, this will go on to reduce the total loan amount of the mortgage while also reducing the monthly payments in the process. So not only does the borrower save some money every month but also saves on the total loan amount in the long run. Since in a refinance, the existing loan is replaced with another, it is important to consider how much the borrower is actually saving through a refinance, by comparing savings with the costs of the refinance, otherwise they might end up with even more costs than before.
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Refinancing to Shorten the Loan’s Term
When considering refinancing a loan’s term, there is a lot to consider. When a borrower refinances their loan term, they reset the clock on the life of the loan. For example, if a borrower’s original loan term was 30 years and after 20 have passed they refinance to a 15-year mortgage plan, they will have a new loan on their hands with a fresh term to complete. Mortgages are a long-term commitment and keeping the details of how the loan term influences a mortgage is key.
Whether refinancing a mortgage loan’s term is a good idea or not depends on the financial position and goals of the borrower. As time passes, it is more likely that a borrower’s income will increase, so it is completely possible for a borrower to be in better financial health as time passes while making payments on the mortgage. By refinancing a mortgage from a long term to a shorter term, a borrower stands to make a lot of savings with highly reduced interest rates. On the other hand, by refinancing a shorter term to a longer-term mortgage the borrower can reduce the burden of monthly payments significantly in the short term, where that money could come in handy in other areas.
Refinancing to Convert to an ARM or Fixed-Rate Mortgage
Mortgages are available with two main types of interest rates, Fixed-Interest Rate Mortgages and Adjustable Rate Mortgages (ARM).
Fixed Interest Rate Mortgages
Fixed-rate mortgages are those where the interest rate remains fixed or constant throughout the life of the mortgage. This allows for calculations of the mortgage’s breakdown to be simple and straightforward. Since the interest rate remains the same, so does the total loan amount.
In an adjustable-rate mortgage or floating rate mortgage, however, the interest rate does not remain constant. It remains fixed for a certain number of years but after that, it changes according to the market. Depending on the market conditions, the interest rate could go up or down. Hence the name “floating rate”.
Refinancing interest rates
The interest rate on a mortgage plan can be changed by refinancing, a borrower will be able to refinance their interest rates from fixed to adjustable interest rates and vice versa. Like with mortgage terms, whether this is a good idea or not depends on the financial position of the borrower and their goals. Both of these interest rates have their own benefits under the right conditions.
Fixed interest rates remain as contracted and do not change regardless of what is happening in the market. This can be a blessing if due to economic problems the interest rate in the market goes up, on the other hand, it can be a loss if the market has lower interest rates compared to the rate of the active loan. Adjustable interest rates depend on the market conditions once their fixed period passes, similarly, the borrower will greatly benefit if the market interest rate is lower and will have to pay more if the interest rate in the market goes up.
Refinancing is an important option that is available for borrowers, however, it is important to first consider the implications of the move before applying for it. There are multiple amazing benefits to refinancing an existing mortgage but ultimately it must not be forgotten that it involves replacing one mortgage for another. Even with better terms, the borrower is choosing to potentially increase the amount of time they remain in debt and depending on the choices involved in the refinancing process, it is possible the borrower can end up increasing their costs overall.
One of the main reasons to consider refinancing is the interest rates and the loan term. Changing these will greatly influence the total amount of the loan and if a borrower makes some smart choices they will not only end up with a loan that costs them less overall but they might also be in a position to pay off the loan faster, a huge part of this depends on how the borrower is doing financially and whether their income can support the decision and outcomes from the refinancing.