Refinancing is the process of obtaining a new mortgage with all or some portion of the proceeds used to pay off the original mortgage.
Homeowners refinance their mortgages for several reasons:
- Interest Rates: It can make sense to apply for a new mortgage to pay off your existing mortgage if interest rates have gone down since you obtained your original mortgage.
- Changing Mortgage Types: Some homeowners refinance in order to switch the type of mortgage they have from variable to fixed interest rate, or vice-versa. Balloon or reset mortgages must either be paid in full or refinanced at the end of their 5- or 7-year term. With a Balloon/Reset, the only other option other than to sell, is to refinance.
- Mortgage Term: Some homeowners pay off their original mortgage in order to take out a loan with a shorter term thus paying less interest because the money is borrowed for a shorter period of time.
- Cashing Out: Certain lenders will let you borrow more money than the balance on your original mortgage based on the equity you have in your home, making additional cash available.
Refinancing can be a good way to reduce your monthly mortgage payments by extending the term of your mortgage. Or shorten the term of your loan to save on interest charges. However, taking out a new loan may involve costs. You may have to pay discount points, appraisal fees, and closing costs up front. Investigate all the fees associated with a new loan before you go to closing so that you make an informed decision as to whether you will save money by refinancing.
Refinancing your existing mortgage will take some time and effort.
Ask Yourself
1. Is the current interest rate significantly lower than the rate of my original loan?
2. Do I want to shorten the term of my mortgage?
3. Do I want to change the type of mortgage I have?
4. Am I prepared to pay the costs of refinancing?
5. Am I planning to stay in my house for at least 2 years?
6. Am I willing to go through the process of getting a mortgage again?
If you answered yes to most of these questions, refinancing may be right for you.
You may want to do more research about refinancing if:
- You’ve had your current mortgage for a long time
- You have already paid off most of the interest on your mortgage
- Your mortgage has a prepayment penalty clause
- You are refinancing to pay off unsecured debt
- You plan to move from your house within 24 months
If any of these statements sound like your situation, talk to a mortgage professional and find out if it makes sense for you to refinance.
Getting Started
Just like when you obtained your first mortgage, Information gathering is the first step.
Consider different refinancing options. Loan products can vary by:
- Interest rate
- Number of points
- Term
- Additional costs
New Options
When it comes to refinancing, there are often more options available than with a first mortgage, such as cash-out refinancing and prepayment penalty mortgages.
Cash-Out Refinancing
Cash-out refinancing is when the amount of your new loan is greater than the amount you owe on your current mortgage. The rest of the amount you borrow comes from the equity in your home and can be converted into cash. This option may be attractive to you if you’re considering making a major purchase or want to use the money to pay for your child’s education. If your interest rate increases when you get a cash-out mortgage, you may be able to deduct more interest from your taxes. Be sure to weigh the pros and cons of tapping into your homes equity.
Prepayment Penalty Mortgage (PPM)
When searching for a first mortgage, many potential home buyers do not get a mortgage with a prepayment penalty clause. However, a prepayment penalty mortgage may be attractive to some homeowners. Mortgages with prepayment penalties may have reduced fees or lower interest rates. Accepting a lower interest rate may make sense to you if you do not expect to prepay the loan and think that you only want to refinance once.
Before deciding on a prepayment penalty mortgage understand all the rules and restrictions associated this type of loan. Be sure to talk with your mortgage professional to make sure that you understand the full conditions of the loan.
As you may know from your first mortgage, mortgage interest is tax deductible. Take into consideration that a lower interest rate means that there is less interest to deduct.
Points
Points paid up front for refinancing and usually have to be deducted over the life of the loan. There are certain specific instances where points may be deducted in one year. Talk to your tax adviser to find out how you should deduct the points you paid from your taxes.
Remodeling & Taxes
Some of the tax laws are different if you are remodeling. If you are refinancing to remodel, be aware that the increased value of your home after improvements may lead to an increase in your property taxes. Interest from loans for home improvements can be deductible. Talk to a tax professional to find out the specifics for your case.
