Refinancing is the process of paying off an existing loan with the proceeds from a new loan, and using the same property as collateral.
Usually, the interest rate on the new mortgage will be less than the old, the loan will cost less and you will save money. However, refinancing isn’t appropriate for every homeowner. To know if it’s right for you, understand how these arrangements work.
Many people choose to refinance because the reduced interest rate decreases their monthly mortgage payment, freeing up cash for other expenses. Every percentage point makes a difference. For example, if you refinanced a $200,000, seven-percent interest loan to a loan with six-percent interest, you’d have about $130 more in your pocket each month.
Another reason to refinance is to repay your mortgage faster, which is done by switching a long-term loan for one with a shorter term. With it, your mortgage payment would be higher, but you’d pay much less in interest over the life of the loan while building equity more quickly.
Cash-out refinancing is yet another attractive option. With this type of loan you’d refinance your current mortgage plus take out some cash from the equity you’ve built up. The benefit? Interest rates on the cashed-out portion are often lower than a home equity line of credit, home equity loan, or second mortgage.
To determine if refinancing will work in your favor, you’ve got to weigh the savings in interest against the fees associated with refinancing. A new loan means you’ll have to pay most of the same costs you paid the first time around. These may include points, appraisals, attorney’s fees (in Attorney states), settlement costs (such as fees for the loan application, title search, appraisal, loan origination, and credit check), recording fees or transfer taxes, and sometimes a pre-payment penalty. All totaled, these costs can be high, and some lenders require at least a portion of them be paid at the time of application.
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