When Does it Make Sense to Refinance?
A refinance can be beneficial in a number of ways. Refinancing your first mortgage can reduce the interest rate, monthly payments, term or a combination of all three. Additionally, a refinance can also provide much needed relief by lowering your payments when your income is too low or debt is too high. To maximize the benefit of a refinance, take a look at your situation. If one or more factors point you toward refinance, then it likely makes sense to start the process.
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You Can Afford It
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When determining the right time to refinance, first decide if you can afford it. Many of the same closing costs involved with a purchase are also charged in a refinance. Closing costs on a $250,000 refinance can run between $7,000 and $9,000. While there are some banks that will allow you to roll the closing costs into the principal amount, keep in mind that you are increasing your principal by almost $10,000. This may not be worth it if you are only saving $100 per month. There should be significant monthly savings in order to justify the expenditure. Furthermore, the expenditure itself should not overextend your means.
You Want a Better Deal
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The most common reason to refinance is to get a lower interest rate. A $200,000 loan at 6-1/2 percent for 30 years carries a principal and interest payment of $1,264.14 per month with $255,085.82 in total interest paid over the life of the loan. That same loan at 4-1/2 percent carries a payment of $1,013.37 per month with $164,813.83. That equates to a savings of $250.77 per month and $90,271.99 over the life of the loan. Another reason to refinance is to lower the term. If you are in a position to make higher payments, satisfying the loan in 15 years is preferable to 30.
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You Want to Consolidate
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You may have reached a point where you not only have a mortgage, but you are also saddled with a home equity loan, credit cards and a car note. If you have enough equity in your home, you can consolidate all your debt into one loan. For example, if your home is worth $300,000 and you owe $150,000, you are at 50 percent loan-to-value since you owe 50 percent of the value of your home. Most banks will only lend up to 80 percent of the value for a conventional mortgage; this means that you can borrow up to $240,000 on a home valued at $300,000. Deduct the $150,000 first mortgage and you are left with $90,000 in net lendable value. So if you have a $30,000 home equity loan, $7,500 in auto loans and $5,000 in credit cards, you can refinance at $192,500, rolling everything into one easy monthly payment.
You Want to Cash Out
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Another good time to refinance is when you need extra cash. You may not need to consolidate other debts, but you may need money for a multitude of reasons, such as a wedding, college tuition or home improvements. Much like consolidation, you need to have equity in your home. For example, if you need $30,000 to pay for your daughter's wedding and you owe $150,000 on your home, you need a total of $180,000. Using the 80 percent loan-to-value ratio, your home will have to be valued at $225,000 at minimum. If you have built the equity and need the money, it is a good time to refinance.
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