The Advantages of Mortgage Refinancing

Refinancing is the replacement of one secured loan with another loan (usually with better or safer terms, such as a fixed rate as opposed an adjustable one, using as collateral the same property. The new loan can be provided by the same lender that provided the original loan or by another lender. The proceeds from the new loan are used to repay the original loan. There is no restriction that the amount obtained through the new loan must be equal to the balance of the original loan; actually it can be larger, if there has been some equity build up since the original loan was obtained borrower and if the owner desires to do so. Depending on the circumstances, the borrower may reap the following benefits from refinancing.

Get a Lower Interest Rate and Reduce Monthly Payment
Interest rates are rarely constant; they move up and they move down subject to national and international forces. So when interest rates are decreasing, many homebuyers and borrowers that mortgaged their properties find themselves holding loans at rates higher than the market rates. In such a case refinancing, that is, taking a new loan at lower market rate will allow them to reduce their mortgage payment (assuming that all the other terms of the loan remain the same).

Tap on Accumulated Equity
If the loan is not an interest-only loan (which is not the case for a typical home loan) the owner accumulates equity, as the loan is repaid through time. Equity accumulation (which is defined as the repayment of the principal of the loan) is very slow in the early years and accelerates as time goes. However, the owner may accumulate equity fast if house or property prices are rising. For example, if prices are rising by 5% per year the value of the house, the dollar amount corresponding to such an increase will represent pure equity gain for the owner. Refinancing can allow the owner to tap into this additional equity that is gained both through repayment of the loan principal and through value appreciation.

Reduce the Risk of your Loan by Switching from an Adjustable Rate to a Fixed-Rate
Adjustable rates are typically lower than fixed rates and many borrowers go for them, especially in periods during which interest rates are stable or/and low. However, when interest rates start rising these loans are becoming very risky for the borrower as his/her monthly payment starts rising too. During such times, refinancing allows the borrower to get a new loan at a fixed rate and repay the adjustable rate mortgage (ARM), thus ensuring that his/her monthly payment will remain stable independently of fluctuations in the economic environment. If the term of the loan remains the same as that of the original adjustable mortgage loan, the borrower’s monthly payment will increase, as the fixed rate will be higher than the adjustable rate. The borrower though may be able to keep the mortgage payment roughly at the same level if the refinancing loan has a longer term than the original ARM. If we keep the interest rate constant, an increase in the term of the loan results in a lower monthly payment. Thus, a longer term may offset the increase in the monthly payment due to the increase in the interest rate.

Eliminate Private Mortgage Insurance Fees
If the borrower is unable to make a down payment equal to the 20 percent of the value of the property mortgaged he/she is required to buy private mortgage insurance. If at the time the refinancing loan is obtained the borrower’s equity has reached the 20% of the value of the property through principal repayment and value appreciation, refinancing can allow the elimination of the fees for such an insurance.