Mortgage refinancing refers to applying for a loan intending to replace an existing loan secured by the same assets bearing different terms.
The most common type is refinancing for a home mortgage. But if the refinancing occurs under financial distress it is referred to as debt restructuring.
Refinancing may be taken to reduce interest rates, to extend the repayment time, to pay off other debts, to reduce one’s periodic payment obligations, or to raise cash for investment or payment of a dividend.
It is also used to reduce the risk coming from an existing loan. Since interest rates on adjustable rate loan and mortgages vary timely, by refinancing an adjustable rate loan to a fixed rate loan the risk of interest rates changing timely can be reduced.
Refinancing a loan can help in paying high interest debt like credit card debt, with lower interest debt such as fixed rate home mortgage.
Most of the fixed term debt contains penalty clauses which ask for early payment of loan. There are also closing and transaction fees which exceed any saving amount generated through refinancing the loan.
Some refinanced loans have lower initial payments which may result in larger total interest over the duration of the loan.
Refinancing lenders require secured payment which is called as upfront payment of a certain percentage of the total loan amount as part of refinancing process. This amount is expressed as “points”. Each point is equivalent to 1% of the total amount. If the option selected involves 3 point then the borrower needs to pay 3%of the total loan as upfront. Paying more points allows an individual to get amount at a lower interest.
To get a new loan borrowers pay an upfront fees. No closing cost refers the financial benefits to refinance if the prevailing market rates are lower than the existing rates by 1.5 percentage points.
It is used for improvement of house and other debt consolidations provided the borrower qualifies for more loan with their current equity. This amount will be larger than the current mortgage.
Let us suppose a loan of 30 years and with $150,000 mortgage is taken with a fixed interest rate of 8%. This carries a monthly payment of $1100. And after refinancing a 30 year mortgage at 6% interest rate is obtained with monthly payments of less than $900. The cost of closing the new mortgage is $5000.
Now let us calculate
Refinance cost : $5000
Monthly savings : $200 per month
$5000/$200 = 25 months
i.e. it takes 2 years to recover the cost
Refinance cost / monthly savings = number of months to recover the costs