From Wikipedia, the free encyclopedia
|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
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.
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.
This is a very important question which all homeowners should ask themselves both at the start and towards the end of the process of re-financing.
The answer to this question can spur the homeowner to investigate re-financing further or convince the homeowner to table the thoughts of re-financing for the moment and concentrate on other aspect of owning a home.
Establish Financial Goals:
This should be the first step in the process of determining whether or not re-financing is worthwhile. Without this step, a homeowner cannot accurate answer the question of the worth of re-financing because the homeowner may not fully understand his own financial goals.
While financial goals may run the gamut from one extreme to another the most basic question to ask is whether the more significant goal is long term savings or increased monthly cash flow. This is important because re-financing can usually achieve these two goals.
Do You Want to Save Money in the Long Run?
Homeowners who establish a goal of saving money in the long run should consider re-financing options such as lower interest rates or shorter loan terms. Both of these options can considerably lower the amount of interest the homeowner is paying on the loan. This is significant because paying less interest will result in a greater cost savings.
Consider an example where a homeowner has an existing debt of $100,000, an interest rate of 6.25% and a loan term of 30 years. Just by reducing the loan term to 15 years the homeowner can significantly decrease the amount which is paid in interest during the course of the loan.
However, this option will also result in an increase in the monthly payments made by the homeowner. Therefore this type of re-financing option may only be available to those who have enough cash flow to compensate for the increase in monthly payments.
Do You Want to Increase Your Monthly Cash Flow?
Some homeowners may have a chosen goal of increasing their monthly cash flow. For these homeowners the overall cost savings may not be as important as having more money available to them each month. These homeowners might consider a re-financing option in which they are able to extend their loan terms.
This means they will be repaying the existing debt over a longer period of time. The homeowner will pay more in interest in the long run but will achieve their goal of lower monthly payments and an increased cash flow.
How Will Re-Financing Affect Tax Deductions?
This is another serious consideration for homeowners who are interested in investigating the possibility of re-financing. The interest paid on a home loan is often tax deductible. A homeowner who re-finances in a manner which results in less interest being paid annually may adversely affect their tax strategy. The implications of this type of chance can be amplified for homeowners who were previously just below a significant tax break line.
A significant decrease in the amount of interest paid will mean a significant decrease in the deduction the homeowner is allowed to take. This reduced deduction can put the homeowner in an entirely different tax bracket and could end up costing the homeowner money in the long run.
For this reason, homeowners who are considering re-financing should have a tax preparation professional determine the ramifications re-financing will have on their tax return before a decision is made.
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