When you refinance a home loan, it means that you are making a complete payment for your previous loan amount and then replacing that loan with a brand new one. There are several reasons that make the house owners refinance their mortgage. The reasons generally include chances of shortening the tenure of their home loan, the opportunity to avail a lower rate of interest, the wish to change from ARM (Adjustable Rate Mortgage) to a mortgage that has a fixed rate of interest or vice versa, the chance to tap the equity for a home for purchasing a bigger property, the opportunity for debt consolidation, etc.
These particular motivations have pitfalls and benefits associated with them. Refinancing a home loan can charge you 3 percent to 6 percent of the total principal amount. If you wish to end your previous mortgage completely, that requires title search, appraisal, fees for application, you must be completely sure that the refinance is offering you great benefits.
Availing an interest rate that is low is one of the most popular reasons for refinancing a home loan. Previously, it was considered to be a good refinance option if you were able to reduce the rate of interest by 2 percent. Nowadays, different lenders suggest that even if you save 1 percent then also it should be an incentive enough for refinancing.
Reducing the rate of interest helps you to save substantial amount of money. It decreases the monthly payment amount that you have to make but can increase the equity building rate for your home. Let us elaborate this with the help of an example. Consider that you have a mortgage for thirty years with an interest rate of 9 percent that is fixed. The principal amount is SGD 100,000. The interest that would have to pay is SGD 804.62. However, the same amount of loan with a 6 percent interest rate would bring down your monthly payment to SGD 599.55
When the rate of interest falls then the house owners get the opportunity for refinancing a current loan for a different loan, without changing the monthly payments much. For a mortgage plan that has a tenure of 30 years and a loan amount of SGD 100,000, the refinance from 9 percent to 5.5 percent splits the total term in half to a period of 15 years. However, there will be slight change of payment as instead of paying SGD 804.62, you will only be paying SGD 817.08 every month.
Adjustable Rate Mortgages do offer rates of interest that are lower than the fixed rate mortgages. However, when there are periodic adjustments then the rates of interest offered by adjustable rate mortgages can reach a point that is higher than the fixed rate mortgage interest. When this sort of a situation happens, then shifting to a fixed rate plan can actually help you to avail lower rates of interest. This also eliminates all other possibilities of hikes in interest rates in the future.
On the other hand, shifting from fixed rate mortgage to adjustable rate mortgage (ARM) has its own perks. It is definitely a good financial strategy to change from fixed rate of interest to adjustable rates of interest when the rate of interest for home loans fall. In case the rates of interest continue to go down then the periodic rate adjustment on the adjustable rate mortgage will result in decrease in the rates and lesser monthly payments will be applicable to you. You will not have to refinance every time the rates take a steep fall if you have an adjustable rate mortgage. Shifting to an adjustable rate mortgage can prove to be extremely beneficial and worthwhile for all those house owners who do not wish or intend to stay in their houses for more than a couple of years. If the rates of interest fall during a certain period of time then it is a situation that these house owners cannot miss out on. They would reduce their monthly instalment payments to a great extent by availing the lower rates of interest. However, since they will not be staying for more than a few years, they will not really bother about the possible hike in rates in the long run.
All the reasons that have been mentioned till now are financially sound. However, refinancing your mortgage can also be pretty slippery associated with debts that never seem to end. It is very important to remember this fact when you plan to refinance for the purpose consolidating your debt or for tapping into home equity.
House owners often make use of the equity in order to cover different huge expenditures, like the total cost of remodelling or restructuring their homes or the education expenses for their children. Such house owners can easily justify their decision stating that remodelling their house adds a significant value to their lifestyle and home. Also, the rate of interest that is charged with the home loan is much lesser than that charged by any other source. Another very common reason for the house owners is that the home loan interests are tax deductible. While all these arguments could be true, increasing the total number of years for repaying the mortgage amount is not a good idea.
There are several house owners who refinance for consolidating the debt amount. Replacing a debt with higher rate if interest with a debt with lower rate of interest could seem like the right thing to do. However, you must understand that refinancing will not really bring an automatic dosage of financial prudence along with it. Truth is, a very big percentage of the people who, at one point of time, generated high debts on their credit cards, vehicles or any other purchase will repeat it after the refinancing of their mortgage provides them with the credit to do such things. This instantly creates a quadruple loss that is composed of equity lost in house, fees wasted in the refinancing process, years added for interest payments on the brand new mortgage and also the high debts that hits you when the credit cards are maxed out once again. The plausible result of this would be endless continuation of the debt and then bankruptcy in the long run.
Refinancing can definitely be a very good decision financially only if it reduces the payments for your mortgage, decreases the tenure of your loan or helps you in equity building. You can also control your debt when you use this this tool carefully. Understand your current financial situation and ask yourself how long you actually wish to spend in the property that you are refinancing.
Also, keep this in your mind that a refinancing would cost you 3 percent to 6 percent of the total principal of the loan amount. It might take you a very long time to recoup that amount with all the savings that are generated by a low rate of interest of a small tenure. Hence, if you do not wish to stay the house for a very long time then the cost of your mortgage refinancing could be more than the potential savings. A good house owner is always trying to find ways to build equity, reduce debt substantially, save a lot of money and also eliminating the payments for the mortgage. Drawing cash out of the equity while refinancing will definitely not help you to achieve these goals.