First-lien refinances in the US was worth almost $400 billion in the first quarter of 2020.
This massive growth was due to mortgage rates dipping to historical lows back then.
All in all, this represented a two-fold rise in refinancing volume from the previous year.
With that said, if you’re a mortgage borrower too, you may want to refinance your current housing loan.
If you qualify, you may be able to trim your monthly mortgage payments, and thus, save big on your housing loans.
The big question now is, exactly what does refinancing a mortgage mean?
We’ll get to the bottom of this below, so be sure to read on.
What Does Refinancing a Mortgage Mean?
The term “refinancing” applies to any outstanding loan that you can “trade” for a new loan, such as a mortgage loan.
In some cases, you can also refinance to change the terms of the existing loan. Aside from mortgages, you can refinance auto or personal loans and credit card debts.
However, mortgage refinancing remains the most common form of loan refinancing.
For example, there were 314% more mortgage refinancing applications in the last week of November 2019 than in the same week of November 2018.
One reason behind this is that refinancing can make sense for larger debts. Now, keep in mind that mortgages are the largest kind of debt that most US consumers have.
In fact, housing loans make up over 71% ($10.15 trillion) of the total household debts in the second quarter of 2020.
With that said, when you refinance a mortgage, you can “swap” your existing loan with a new loan. You can do this with the same lender or a different lending institution.
If you do this, your old mortgage contract “dissolves,” as you would take on a new loan contract.
How Does Refinancing a Mortgage Work?
When you refinance your mortgage loan, the new loan you take on pays off your old one. Since you have a new loan, you’ll also have a new contract, including new payment amounts and due dates.
Most homeowners who refinance do so to take advantage of lower mortgage rates. Many others go for refinancing to reduce their monthly repayments.
In other cases, borrowers refinance as they need to extend their repayment term.
When Does Refinancing Make Sense?
Refinancing isn’t for everyone, as it usually still requires at least a good credit score.
That’s because the refinancing process is much like the standard mortgage loan process. Most of the qualifications for refinancing mimic those for first or second mortgages.
Still, there are several situations wherein mortgage refinancing makes a lot of sense. We’ll delve into each of these below.
To Obtain a New Housing Loan With a Lower Interest Rate
A report said that those who refinanced earlier this 2020 could save an average of $272 a month. These savings would come from the reduced mortgage rates of the refinanced loan.
In this situation, borrowers could save an average of $3,264 within a year.
It’s during these times when loan rates drop that refinancing a mortgage makes a lot of sense. A small percentage difference in your loan rate can already generate a lot of savings.
Using the example above, you could save over $30,000 within a span of 10 years.
Do note that the example above doesn’t always occur, as extreme dips in rates don’t always happen.
Still, if mortgage rates do drop, you should consider taking advantage of it as it can help you save a lot.
To check how much you can save, you may want to use a mortgage calculator on a financial website.
To Lengthen Your Mortgage Term
You can also refinance your mortgage if you believe you need a longer time to pay back your debts.
Suppose that your family has grown, so your household expenses have also increased.
In this case, your monthly mortgage repayment may already be out of your budget’s comfort zone.
You can then refinance your existing housing loan to get a new one with a longer repayment term.
By extending the life of your mortgage, you can then lower your monthly payments.
This, in turn, reduces your overall monthly household expenditures. In addition, the trimmed amount you have to pay your lender back can help make repayment easier to manage.
However, keep in mind that lengthening the term of your mortgage will raise the total cost of your loan.
That’s because you’ll have more monthly payments to make over the life of your mortgage. This is still better than missing mortgage payments, though.
To Shorten Your Mortgage Term
Most of the time, the shorter the mortgage term is, the lower its interest rate. For instance, the common interest rate of a 15-year fixed mortgage is around 5.5%. By contrast, the interest rate of a 30-year fixed mortgage is usually about 6%.
Now, that 0.5% difference is a huge deal, seeing as mortgages involve a large amount of money. The bigger the principal loan amount is, the more considerable your savings would be.
As such, if you think that you could afford to shorten your mortgage term, you should think of refinancing.
Just remember that if you do shorten your term, you will make higher monthly payments.
That’s because your repayments would get spread over a fewer number of months. That’s why it’s crucial to ensure that you can afford this increase in your monthly mortgage dues.
Go for Refinancing Only When It Makes Sense
There you have it, the guide that answers your question, “what does refinancing a mortgage mean?”
Now that you know what it is and when it makes sense to refinance a mortgage, you can make a wiser borrowing decision.
If it can save you money or if it will help you avoid defaulting on your loan, then, by all means, consider refinancing.
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