But why refinance as opposed to taking out that second loan? The first consideration is the interest rate. If a homeowner has been making their payments on an adjustable rate mortgage that has reset to a higher rate, they may be better off applying for a refinance mortgage. Depending on the credit history, a fixed rate mortgage may be available.
You may be able to extend the time-frame for repayment of a refinance mortgage. By extending the period for repayment, the borrower reduces their monthly payments. Any money saved can be used to pay down the loan principal amount. By reducing the principal, you can reduce the term of repayment. Make certain that your loan does not have a pre-payment penalty.
Some borrowers may wish to liquidate some of the equity in their property. Maybe they would like to pay off some high interest credit card debt, a car loan or make some home improvements. If there is equity in the home, this type of loan may be possible.
Since interest rates on an adjustable rate mortgage (ARM) shift up and down over time, it may be advantageous to lock in a lower fixed rate mortgage. A fixed rate mortgage (FRM) will ensure that the required payments over the loan term don’t fluctuate.
Some borrowers have opted for what is referred to as Cash-Out refinancing. This refers to the process of refinancing an existing loan to remove the equity. Typically, people will do that to pay off high interest non-secured debt.
There may be tax advantages to a mortgage over credit card or other non-secured debt. Non-secured loans may not be tax deductible. The interest on a mortgage may be tax-deductible. A change in deductions may also shift the borrower into a lower tax bracket. Always check with your tax professional or financial advisor first.
But there are risks associated with a cash-out or refinance loan. Although you may save money on mortgage payments and taxes, you are putting your home up as collateral for the loan. Your house may be at risk of foreclosure if you are unable to make the payments.
The borrower may also be faced with higher loan fees and points. Points are a percentage of the loan and can be used to lower the interest rate. Typically, if you pay more points you may get a lower interest rate and lower payments. Some lenders will offer to finance parts of the loan themselves, thus generating so-called "Negative points" (also called discounts).
A refinance loan should be weighed against the alternatives; either keep your existing loan or take out a second mortgage. If your existing rate is 1.5 percentage points or more that the refinance rate, it may be beneficial to refinance. But over the long-run, a refinance mortgage may be the best alternative.
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