Refinancing a mortgage includes paying off the existing mortgage and replacing it with a new loan. Sometimes, it is even possible to combine a first and second mortgage into a new loan. Many homeowners refinance to take advantage of market conditions or to change their loan type. Homeowner’s might refinance when interest rates are low and switch to a different type of mortgage, saving money and getting cash from equity in their home.
For homeowners who have great credit, refinancing can be a good way to transform an adjustable-rate mortgage into a fixed rate with better terms. On the downside, borrowers with bad credit and high debt may be risking too much by refinancing.
Many mortgage agreements have a provision that allows the lender to charge the borrower if the existing mortgage is paid off with a home equity line of credit. It’s crucial to find out if such penalties exist to decide whether it will be worth it to refinance.
One of the biggest drawbacks when it comes to refinancing are prepayment penalties. The clause in the current mortgage stipulates that lenders can charge penalty fees if the mortgage is repaid before 2-5 years.
Refinancing is not without closing costs and refinancing a loan to a lower rate may not be the wisest decision after these costs are taken into account. Closing costs typically run around $4,000 for a $200,000 mortgage. Before refinancing, borrowers should know how many months it will take to recover all the closing costs.
If you owe more on your mortgage than what your home is worth, you will have very limited options for refinancing. Lenders usually ask that borrowers have 20% equity in their home to refinance. Despite this, there are other options available.