Whenever interest rates plummet, homeowners jump to refinance mortgages right away, often without considering first whether doing a refinance makes financial sense, or if it's a good idea at all. Unfortunately, most homeowners quickly fall into the trap of low-interest rates, not knowing that it's only a small portion of the bigger picture.

A mortgage refinance works by replacing your existing home loan with a new one. Most people refinance to tap into their home's equity, reduce the interest rate, or cut monthly payments. Others acquire mortgage refinance to get rid of FHA mortgage insurance, switch to a fixed-rate loan, consolidate debt, or pay off the loan faster.

Whatever may be the case, it pays to get to know the nature of home loan refinance, up close and personal.

What Is a Refinance?

Refinancing a loan is a process that enables the borrower to replace his or her on-going debt obligation with another loan with more advantageous terms. The borrower will get a new loan to pay his or her present debt, and the updated agreement will replace the old loan agreement.

It also allows the borrower to redo his or her loan to get a different term length, more convenient payment structure, or a lower monthly payment. Apart from traditional banks, consumer lenders with traditional loan offerings also give refinancing options. But refinancing loans impose slightly higher interest rates for products like car loans and mortgages than purchase loans.

Types of Refinance Mortgage Loans

Even if you're paying on a fixed-rate mortgage, you can still apply for another type of mortgage loan whenever you decide to refinance. Just make sure you completely understand the terms of the new loan before switching out a fixed-rate mortgage for another type.

Here are the common types of mortgage loan you may want to consider:

  • Option ARM Mortgage

  • Interest-Only Mortgage

  • Adjustable-Rate Mortgage

  • Reverse Mortgages

  • FHA Loans

Refinancing a Mortgage

When you purchase a home, you also obtain a mortgage to pay for it, and then the home seller gets the money.

Almost the same process applies when you refinance: you refinance, and you get a new mortgage. But the new mortgage pays off the balance of the old home loan instead of going to the home seller.

Moreover, mortgage refinancing will still require you to qualify for the loan, just as you had to meet the requirements of the lender for the original mortgage. You will submit a loan application, undergo the underwriting and closing process, just like what you did when you purchased the home.

Why and When to Refinance

It's important to deliberate on why you want to refinance your home loan thoroughly. You need to have feasible goals because it will guide the whole mortgage refinancing process.

  • Minimize the monthly payment. If your goal is to reduce the monthly payment, you can refinance a loan with a lower interest. Extending the loan term, say, from 15 years to 30 is another way to pay less every month. The only snag with extending the term is that you'll pay higher interest in the long run.

  • Pay the loan faster. You'll be able to pay the loan for half of the timeframe. If you refinance, say, from a 30-year mortgage into a 15-year loan. You will only pay less interest over the life of the loan as a result. However, a 15-year loan has its fair share of disadvantages. One drawback is that the monthly payments typically increases.

  • Tap into equity. The lender will give you a check for the difference whenever you refinance to borrow more than what you owe on your present-day loan. This process is called cash-out refinance.

  • Transfer to a fixed-rate loan. The adjustable-rate mortgages have interest rates that may increase over time. But with fixed-rate loans, the interest rates stay the same. Unlike the ARM, refinancing a fixed-rate loan will provide financial stability if you want steady payments.

  • Remove FHA mortgage insurance. While it's allowed to cancel private mortgage insurance on conventional home loans, it's not possible with FHA MIP (Federal Housing Administration Mortgage Insurance Premium) loans. The only solution to remove FHA insurance premiums is to refinance the loan or sell the home when you already have sufficient equity.

Use a Mortgage Refinance Calculator

If you're fully resolved to take on refinancing, working on the numbers is the next thing to do. You will need a mortgage refinance calculator to do it.

You have to make some educated guesses or know about your new loan amount and its new interest rate. After you put the required data, the tool will compute your new payment, monthly savings, and lifetime savings. A mortgage refinance calculator also computes your "break-even" point. Know it that getting a mortgage in general demands fees that often amount to thousands of dollars. It usually takes a while for a refinance to break even.

Moreover, using a refinance calculator will give you clear expectations when it comes to payments. Even better, you can compute the offered terms from the lenders if you have a few estimates from them to help you get the best deal.

Shop the Best Refinance Rates

After doing the calculations, it's time for some phone calls and web work. This is a crucial step, not just for refinance loans, but to every type of loan there is. Be it a business, a personal CreditNinja Loans, auto loan, etc. You need to get a loan estimate and shop for your best mortgage refinance rate from each lender.

Every potential lender typically issues the estimate three days after receiving your personal details. The loan estimate is usually a three-page document that contains the projected payments, loan terms, estimated closing costs, and other fees.

After receiving the loan estimates, make a thorough comparison with the loan details from each lender and choose the one that suits best with you. Again, you do it by working with a mortgage refinance calculator.

Takeaway

Refinancing can be an excellent financial maneuver if it will shorten the term of your loan, reduce mortgage payments, or help you establish equity more quickly. It can also be a useful tool to manage your debt if used carefully.

But before you jump to refinancing, be sure to evaluate your financial situation and ask yourself: How much money will I save by refinancing? How long do I plan to continue living in the house? If you have reasonable answers to these questions, then you can start working on refinancing your home loan.

Author Bio:

Tiffany Wagner is a full-time content writer and curator who works for various websites. Her knack for finance, real estate, and business management is evident to her written works. When she's not writing, Tiffany usually spends her time sipping a cappuccino in her favorite shop while playing Sudoku.