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3 Things to Know About Mortgage Refinancing

Mortgage Refinancing Is Not Right for Every Home Owner

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Mortgage refinancing makes sense if you'll save money after a few years.

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Mortgage refinancing is all the rage when interest rates drop. Rates don't have to drop very far, either, before scores of home owners decide that refinancing their mortgages makes sense. But it doesn't always make financial sense to refinance.

What is Mortgage Refinancing?

Refinancing a mortgage means the owners are paying off their existing mortgage and replacing that mortgage with a new loan. Generally, the costs associated with mortgage refinancing are rolled into the loan, meaning they are added to the existing balance, increasing the loan amount.

When a loan amount is increased, an owner's equity is decreased.

It is possible to increase the principal balance of a mortgage and lower the existing mortgage payment. That's why many borrowers gravitate toward mortgage refinancing. To lower the existing mortgage payment, the term of the loan is extended. But a lower payment might not pay off in the long run.

Why Mortgage Refinancing Extends the Term of Your Mortgage

When the term of the loan is extended, it will take longer to pay that mortgage in full. If you took out a loan when you bought your home, it was probably a 30-year loan. Say you decide to refinance your mortgage at the end of 5 years. Instead of looking forward to paying off your loan in 25 years at this point, you will now be paying on that mortgage for a total period of 35 years.

If your original loan was amortized for 30 years on a $100,000 mortgage at 6% interest, your monthly payment is $599.55. If you refinance that mortgage at $103,000, at 5.5%, your new payment is $584.82. Your loan will reset to a 30-year term. Most borrowers select a 30-year amortization period.

You will make an extra 60 months of payments and pay $35,065 more over the life of the loan, should you live in the property long enough to pay off your loan. If you decide to sell after mortgage refinancing, you will lose $3,000 of equity, plus whatever principal balance you had paid down on the original $100,000 loan.

Costs Associated With Mortgage Refinancing

You will either pay for the costs of mortgage refinancing through a higher interest rate or those fees will be added to your unpaid mortgage balance. There is no free ride. Following are typical fees paid to obtain a refinance:

It's hardly worth it to refinance your mortgage to save $15 a month under these circumstances. Most mortgage experts say you should be able to recoup your costs from mortgage refinancing over a 3-year period. If you've saved only $15 a month and it cost you $3,000 in fees, it would take 200 months to break even.

At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.

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