Refinancing is the act of paying off your original loan with a brand new loan from a new lender. If you have a home loan, because you are ending your current loan, you do have to pay all closing costs and any prepayment penalties which can actually be very costly, so you’ll want to look through the terms of your loan to see if this applies to you. Other than the closing costs, you will also have to pay all the fees for opening your new loan just as you did the first time. These include loan application fees, appraisal fees, for your property, title search and title insurance, loan origination fees, mortgage insurance, and other applicable fees involved in getting a new home loan.

If there are so many other costs, why bother refinancing?

Depending on your particular goals there are many good long term reasons to do this that we can see when we look at more about how does refinancing work.

A great reason for refinancing a loan is for lower interest rates. As a general rule it’s only worth the effort if you will be getting a 2% lower interest rate and will be staying with the loan three years as this is the point most people experience the benefits. It’s always important even with these rules to go over the numbers carefully to make sure refinancing is worth it.

Another popular reason is to switch from an adjustable rate mortgage to a fixed rated if the changing monthly payments are making you uncomfortable. You can also stretch out your loan payments and make each monthly payment smaller. This will make it so you pay more in interest total, but if you need to lower your monthly budget this is an option.

People with high interest debts can obtain a loan for more than they currently owe on their home to pay off their debts in favor of lower interest rates and tax deductible payments on a home loan. The bad side to this being that if you miss a payment you will lose your home, and you are extending the life of your mortgage.

As we have seen, there are many reasons for refinancing, but they essentially work the same way.

How does refinancing work? You close out your loan with a new one, first carefully calculating out the benefits to make sure the work will be worth it long term.

The most basic thing you need to know is that to refinance means you are getting a whole new loan and starting over. This means that on top of closing your current loan you need to open a new one, and as I’m sure you remember, there are a lot of fees to take care of when you get a mortgage. To decide whether it’s really a good idea you really do need to go through and tally up all the individual costs, you can however, make a general estimate. On average, assuming you don’t have any prepayment penalties, your costs will be around 3% to 6% of what you have left to pay on your mortgage. If your current loan has prepayment penalties that will be an additional expense.

When you see those numbers it can easily feel like this is something you shouldn’t do, but before you make up your mind take a look at the numbers you can save and that will tell you when to refinance.

When you get a new loan you are hopefully getting a new, lower, interest rate. As a general rule of thumb you want to look for a rate that is two percent lower to make it worth it. This will lower your monthly payments. Figure out how much you will save monthly and then how long it will take for that savings to pay off. Now, and here is the important question of when to do this, will you still be living in the house then? Because if you’re not, it is a waste of money to go through with this plan. If you will be, then you will be saving yourself money over the life of the loan and the sooner you do this, the sooner you save money.

Of course, there is another important factor for when to refinance involved in the search for that pivotal number- the lower interest rate.

I recommend looking at five companies before picking one to compare rates and terms. When you have the companies with the lowest rates picked watch them for a while- the rates go up and down, if they are on a downward slope, wait a little while until they hit the number you really want. Of course, don’t wait too long or they’ll start to jump back up again.

You want to make sure all these factors come together for you with the high costs involved you really only want to ever do this once. This can be a great thing that saves you a lot of money as long as you know when to refinance.

In it’s basic form it’s actually quite simple. Refinancing is financing again, paying off your home loan with a new one. However, if you remember the experience of your original loan process, you know it can take a bit more than how it sounds, and this time you have closing your original loan to think about.

Almost all loans have closing costs, and you’ll want to look through the terms of your loan to see what those will be for you. You also want to see if you have prepayment penalties to deal with as they may be costly.

Just like the first time around you’ll need to handle application and appraisal fees, lender attorney review fees, title and mortgage insurance, and other applicable fees. Most homeowners should plan on paying 3-6% of what’s left on the loan in refinancing costs, plus any prepayment penalties. If you have a second mortgage, you’ll need to pay that off as well.

With all that, explain why I should refinance?

My favorite reason is lowering interest rates. If you will be staying with your home for at least three more years and can decrease your interest rate by two percent most financial experts advise pulling out your calculator and seeing if this will be worth it long term for you.

Other popular reasons include switching to a fixed interest rate, stretching out or shortening the length of your loan to adjust your monthly payment amount, or borrowing more money than you have left to pay on your loan to pay off high interest debts in favor of the lower interest rate.

Whatever your reason for pursuing it, if the numbers say refinancing will be beneficial for you, you should start looking at local lender rates and remember at any point in the process you can ask them more questions and get them to explain refinancing your home.

It’s very important to understand how this works because it will affect your decision to refinance or not.

When you have a new loan you will have new terms. Depending on what your goals are, you could find a fixed interest rate, a lower interest rate, lower monthly payments, paying it off sooner or stretching it out. A whole new start gives a whole new set of opporotunities. Because you have already paid some on your original loan your new one will be for less money, which also gives you more options.

If you are thinking about refinancing something must have changed from the time you originally got the loan. This could be an improved credit score, a change in employment, a new financial goal-whatever it is, it is good to consider this when planning and what it means you’re looking for in a loan.

In different circumstances refinancing means different things for diffent people. For instance, students may want to refinance their student loans because during the time they were students they have built up a better credit score and want to now obtain better rates and a payment plan that works with their post-graduation life.

Homeowners may have originally been grateful when they signed up for their loan, but now may be wondering if they got the best deal? Or now they are regretting their adjustable interest rate and are looking for a fixed rate.

Some may also be looking to fund home improvement projects. In this case, you look for an amount greater than what you currently owe, the extra going toward the improvement project.

It is important to keep in mind that whatever closing costs apply to your original loan will still apply and will have to be dealt with when moving on.

Whatever your situation, the answer basically remains the same. What does the financial term refinancing mean? A new start.

What are the pros of refinancing?

Lower interest rates is one of the best reasons to refinance. As a general rule of thumb, if you can get 2% lower rates you should calculate your costs out as it will likely be worth it.

To obtain a fixed interest rate. If you are uncomfortable with an adjustable rate and worried about the rate increasing, you can refinance for a fixed rate.

To pay off high interest debts or fund home improvement projects you can get a loan for a larger amount than your owe on your house.

You can extend the life of your loan. While you will pay more in total interest, this will lessen the amount you pay each month.

What are the cons of refinancing?

Refinancing is the act of obtaining a whole new loan. You have to pay the closing costs on your original loan including any prepayment penalties.

If you do not calculate all fees associated with closing the original loan and starting the new loan versus any savings you might be counting on with your new interest rate then you could end up losing money.

If you are borrowing more money by refinancing and haven’t planned out your new budget carefully and miss payments you could risk losing your home.

It usually takes three years to realize the financial benefits so if you won’t be staying with the loan for that long it is generally not worth the costs and trouble.

In conclusion, what are the pros and cons of refinancing?

While there are various goals which change individual pro lists, it really comes down to a balance of numbers, and a careful consideration of the long term effects. If you consider all aspects and keep track of all of the numbers realistically with a calculator, you should be able to easily see if the numbers make sense for pursuing refinancing.

The first is your reason for doing this. Are you looking for a lower, or a fixed interest rate? Or are you looking to stretch out the length of your loan for lower monthly payments, or possibly shorten it? Another common reason for refinancing a mortgage is to borrow more money to fund a project or pay off high interest debts in exchange for a lower rate with tax deductible payments.

Once you have your reason and know what you are looking for everything comes down to numbers.

Let me explain, hopefully you are planning on gaining some money, long term, from refinancing. However, to make sure you are going to have these benefits, you want to calculate your upfront costs.

The first costs to consider are closing out your original mortgage. Most loans have closing costs associated with them. You’ll want to look over the terms of the loan for that. You also want to check for prepayment penalties, as these can really add up and make refinancing undesirable.

When you apply for the new loan you have all the fees that you had to pay for your original home loan, including title fees and insurance, home appraisals, etc.

If after carefully calculating all of these upfront costs out you come out ahead, then this will be beneficial for you. As a general rule, you should move forward if you find an interest rate that is 2% lower than you are currently paying. It’s important to keep in mind, however, that refinancing a mortgage is only usually worth it if you plan to stay in your home three years as that’s usually the point most realize profits from refinancing.

I know that the process can be confusing and it’s important to remember throughout the process that you can always ask your lenders questions as you go through to explain refinancing a mortgage.