Refinancing is defined as replacing an existing debt obligation with a new one with new terms. The most common obligation that is refinanced is a home mortgage.
Most people who seek refinancing are looking for one of two advantages (or both); (1) A more reasonable interest rate, and (2) a shorter term on the loan. Of course, if you found yourself on the bad end of an adjustable rate mortgage (ARM), you should not agree to any refinancing that does not convert your mortgage to a fixed rate.
Lower Interest Rates
People who are looking for reasonable interest rates need to understand that certain factors dictate the rates such as your credit rating and the amount of the down payment that you were able to afford. But the most important factor is the prevailing rates at that moment. When the Federal Reserve enters a rate-cutting period, the prevailing rates may become significantly lower.
It just makes good financial sense to refinance your mortgage when interest rates are lower. If you are able to exchange a higher interest rate for a lower one, you will lower your monthly payment. This is the goal of every home mortage refinancing.
Shortened Term of Loan
Shortening the term of a loan can save you thousands in interest. Let's think about this for a minute. If you had a 30 year loan and then you change it to a 15 year loan, you just saved yourself 15 years of payments. Along with these 15 years of payments went 15 years of interest. I realize that there is less interest on the tail end of a loan, but there is still interest nonetheless.
Fixed Rate vs Adjustable Rate
A few years ago banks and other financial institutions were signing a huge number of adjustable rate mortagages (ARM). When you are involved in an ARM, your mortgage rate will periodically be adjusted according to a variety of different indicies such as the cost of funds index. When mortgage rates are low, ARM's are very attractive to to perspective homeowners. But once the rates begin to rise, these same homeowners find themselves trapped in a terrible situation. It is a sound financial decision to exchange your adjustable rate mortgage for a fixed one. At least then you will be capable of some financial planning because you know what your mortgage payments will be from one year to the next.
Home Equity Loan
Equity is defined as the difference between the home's fair market value and the outstanding balance of all of the loans against the property. This equity can be taken out of your loan when you refinance. This money can be used to pay off other financial obligations, can be reinvested in the home in the form of home improvements, or can just simply be used as cash. Remember that when you take the equity out of a house it is gone forever and you must work for years to build up equity again.
One additional advantage of refinancing your home is now you can get rid of private mortgage insurance (PMI). If you had bad credit, could not afford a down payment or were looked upon as a high risk for any reason, your financial institution would require you to carry this PMI. When you are refinancing, you might be eligible for a loan that has no PMI, this will also lower your payments.
There are many refinancing options out there that will assist homeowners with lowering their monthly payments and restructuring their home mortgages into something that is more reasonable.