Refinancing refers to the replacement of an existing debt obligation with a debt obligation bearing different terms. The most common consumer refinancing is for a home mortgage. A mortgage is the pledging of a property to a Lender as a security for a Mortgage loan.
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Advantages
Refinancing may be undertaken to reduce interest costs (by refinancing at a lower rate), to extend the repayment time, to pay off other debts, to reduce one's periodic payment obligations (sometimes by taking a longer-term loan), to reduce or alter risk (such as by refinancing from a variable-rate to a fixed-rate loan), and/or to raise cash for investment, consumption, or the payment of a dividend. Interest is a fee paid on borrowed capital Assets lent include Money, Shares, Consumer goods through Hire purchase, major assets Debt is that which is owed usually referencing Assets owed but the term can cover other obligations
In essence, refinancing can alter the monthly payments owed on the loan either by changing the loan's interest rate, or by altering the term to maturity of the loan. More favourable lending conditions may reduce overall borrowing costs. Refinancing is used in most cases to improve overall cash flow.
Another use of refinancing is to reduce the risk associated with an existing loan. Interest rates on adjustable-rate loans and mortgages shift up and down based on the movements of the various indices used to calculate them. This article is about index in an economics and finance sense By refinancing an adjustable-rate mortgage into a fixed-rate one, the risk of interest rates increasing dramatically is removed, thus ensuring a steady interest rate over time. This flexibility comes at a price as lenders typically charge a risk premium for fixed rate loans.
In the context of personal (as opposed to corporate) finance, refinancing a loan or a series of debts can assist in paying off high-interest debt such as credit card debt, with lower-interest debt such as that of a fixed-rate home mortgage. A credit card is part of a system of Payments named after the small Plastic card issued to users of the system This can allow a lender to reduce borrowing costs by more closely aligning the cost of borrowing with the general creditworthiness and collateral security available from the borrower. For home mortgages, in the United States, there may be certain tax advantages available with refinancing, particularly if one does not pay Alternative Minimum Tax. Alternative Minimum Tax ( AMT) is part of the Federal Income tax system of the United States.
Risks
Most fixed-term debt contains penalty clauses (known as "call provisions") that are triggered by an early payment of the loan, either in its entirety or a specified portion. A payment is the transfer of wealth from one party (such as a person or company to another In addition, there are also closing and transaction fees typically associated with refinancing debt. In some cases, these fees may outweigh any savings generated through refinancing the loan itself. Typically, one only rationally considers refinancing if the potential for a substantial cost savings exists, or if there is a need to extend the loan due to weak cash flow or other non-recurring commitments.
In addition some refinanced loans, while having lower initial payments, may result in larger total interest costs over the life of the loan, or expose the borrower to greater risks than the existing loan, depending on the type of loan used to refinance the existing debt. Calculating the up-front, ongoing, and potentially variable costs of refinancing is an important part of the decision on whether or not to refinance.
Points
Refinancing lenders often require an upfront payment of a certain percentage of the total loan amount as part of the process of refinancing debt. A point, sometimes also called a " discount point " is one of the important factors in the calculation of the Annual percentage rate for a Mortgage Typically, this amount is expressed in "points" (also sometimes called "premiums"), with each "point" being equivalent to 1% of the total loan amount. Therefore, if the refinance option selected involves paying three points, then the borrower will need to pay 3% of the total loan amount upfront. Most refinancing lenders offer a variety of combinations of points and interest rates. Paying more points typically allows one to get a lower interest rate than one would be capable of getting if one paid fewer or no points. Alternately, some lenders will offer to finance parts of the loan themselves, thus generating so-called "negative points" (also called discounts).
The decision of whether or not to pay points, and how many points to pay, should be taken in consideration of the fact that with points, one tends to trade a higher upfront cost in exchange for a lower monthly premium later on. Points can be paid out of the cash saved by refinancing the loan in the first place.
Types
No-Closing Cost
Borrowers with this type of refinancing typically pay few upfront fees to get the new mortgage loan. In fact as long as the prevailing market rate is lower than your existing rate by 1. 5 percentage point or more, it is financially beneficial to refinance because there is little or no cost in doing so.
However, what most lenders fail to disclose is that the money you save upfront is being collected on the back through what's called yield spread premium (YSP). The yield spread premium (YSP is the cash rebate paid to a Mortgage broker based on selling an Interest rate above the wholesale Par rate that the Yield spread premiums are the cash that a mortgage company receives for steering a borrower into a home loan with a higher interest rate. The latter will even eventually lead to borrower's overpaying.
Cash-Out
This type of refinance may not help lower the monthly payment or shorter mortgage periods. It can be used for home improvement, credit card and other debt consolidation if the borrower qualifies with their current home equity; they can refinance with a loan amount larger than their current mortgage and keep the cash difference.
See also
References
- ^ Pitfalls of a 'No Closing Cost' Refinance. In banking and finance refinancing risk is the possibility that a borrower cannot refinance by borrowing to repay existing Debt. Lender Review Board. Retrieved on 2008-03-05. 2008 ( MMVIII) is the current year in accordance with the Gregorian calendar, a Leap year that started on Tuesday of the Common Events 363 - Roman Emperor Julian moves from Antioch with an army of 90000 to attack the Sassanid Empire, in a
External links
- U.S. Department of Housing and Urban Development - Streamlining your Mortgage
- U.S. Department of Veteran's Affairs - Mortgage Refinancing Information
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