I hope everyone has enjoyed their holidays. I know I did, although I have gained a few extra pounds to work off in the new year.
Below I will go over the reasons why one should consider refinancing and the underlying options available. Also, I will include some examples as there are many different situations that apply to refinancing. All examples below are assuming a conforming "good credit" borrower, except in the case of debt consolidation.
Lower term/lower payment refinances
The most common type of refinance is to lower the term of the current loan or to lower the current monthly payments. This happens when the interest rate on the new loan is around 1.5% or more lower than the interest rate on the current loan. In some cases, the refinance could be at a rate low enough that it both lowers the term and the monthly payments. The most advantageous way to save money is to lower the term of the loan because it can save thousands over the course of the loan.
Example: John and Kelly refinance their home from a 30 year fixed 7.5% to a 15 year fixed 5.625%. Their current loan balance is 95k and have owned the house 6 years never refinancing. The original loan amount was 110k and the monthly payments are $769. The proposed payments for a 15 year at 101k (which includes closing costs) would be around $831. So they end up paying only $62 per month extra, or 62x12=$744 per year, or 744x15=$11,160 over the life of the loan. However, in 15 years the house will be paid off, but without the refinance they would still have another 9 years of payments at 831x12x9 years=$89,748 savings of interest!
Many people are refinancing as a way to cut out those exorbitant credit card payments and even to consolidate car loans. This is a great way to get out of credit card debt and start on a clean slate. Some people that refinance with a debt consolidation do not have the best credit score so they are not able to get the best rate available to good credit holders, however, they are still able to lower their monthly payments because of the higher interest rates associated with credit cards.
Example: Scott and Donna refinance their home from a 30 year fixed 9.5% to a 25 year fixed 9.25%. Their current loan balance is 95k and have owned the house for 5 years never refinancing. Their total credit card debt is 10k with various different card companies which forces them to pay $250 and their original loan amount is 110k with monthly payments of $769. In addition, they have a car loan that they pay $250, with 4 years remaining at a current balance of 10k. They would like to consolidate all their debt including the car loan because of money issues. Even though they could not command an interest rate that much lower than their current, their new payments on a loan of 121k (includes closing costs) would be $1,036. Currently with all debt they pay $769+250+250=1269, so this loan saves them $233 per month, or $2,796 per year.
In my next article I will discuss two other options: Cash-out refinance and construction refinance. Until then, enjoy the new year!