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Transferring mortgages: The pros and cons of mortgage refinance

Switching Mortgages: The benefits of mortgage refinancing
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Transferring your mortgage to another lender can be a great way to get the best rates possible. Although switching mortgage providers might seem like needless paperwork, it can save you thousands of dollars. 

Instead of spending thousands of dollars in interest payments, a greater percentage of your money will be used to pay off the principal of the loan. This means you will build up the equity in your home at a faster rate. To get your home for less, you should look to remortgage. 

This article will give you a basic overview of the benefits to refinancing your mortgage as well as discussing the risk of refinancing at a bad time. We'll also discuss the types of mortgage refinancing available. 

 What is mortgage refinancing?  

The term most financial organisations use for transferring or switching to a different mortgage is mortgage refinancing. So if you have been looking into the advantages of switching mortgages and find yourself getting confused by this term, don't worry. It is just financial jargon. 

For the sake of clarity, we define mortgage refinancing as replacing an existing mortgage with a brand-new mortgage. When you refinance your mortgage you are not limited to renewing the mortgage with your current lender either, as you can shop around for the best deal. 

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How does mortgage refinancing work? 

Switching mortgages works by you taking out a new mortgage to settle the existing mortgage. So in essence you are borrowing the same amount, just from a different lender. To settle the first mortgage there will usually be a closing cost fee included too – which might mean you have to pay a little more to close the first mortgage. 

That may sound stupid but it does offer some financial advantages, like lower mortgage rates that will save you more in the longer run or a longer term that will decrease monthly payments. 

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The benefits of mortgage refinancing

There are many financial benefits to refinancing your mortgages. The pros and cons  depend heavily on your personal circumstances, of course. But most lenders switch mortgages for the following reasons, many of which may apply to you:

Get a loan that suits the present you

The biggest advantage of refinancing your mortgage is to get the best deal that suits you now. The trouble with long-term loans, like mortgages, is we outgrow the terms and rates quickly. What was a great deal for you five, ten or even 15 years ago might no longer suit your current circumstances. Refinancing your mortgage will give you the opportunity to shape the mortgage to your current circumstances.

Get lower interest rates

Most people refinance to lower the interest rates on their existing loan. Most experts suggest waiting until there will be a 2% drop in the interest rates to refinance your mortgage. Although, others suggest a 1% drop is a big enough reduction on your interest repayments for it to be beneficial. Lowering the interest rates will allow you to build equity in your home faster and decrease your monthly payments. 

Reduce monthly payments

Mortgage refinancing can lower the monthly repayments you make. Most people own a larger share of equity in their home when they refinance. This means you can borrow less for the same term of the original loan. This can drastically reduce the monthly fee and make budgeting a lot easier. 

Get a different mortgage type 

Another great reason to refinance is to change the type of mortgage you have. The most common type of change is from an adjustable-rate mortgage to a fixed-rate mortgage. The interest rates on adjustable-rate mortgages fluctuate, meaning that your monthly payments may have increased since you took out the mortgage. By switching to a fixed-rate mortgage when interests are low, you can lock yourself into a low monthly repayment for years to come.

Remove your private mortgage insurance

If you have borrowed more than 80% of your home’s value in a single mortgage you will have to take out private mortgage insurance (PMI). These monthly payments are expensive and only protect the bank from non-payments. 

PMI can be removed when your loan-to-value ratio reaches 78% of your home's original value. If your home has increased in value, a faster way to remove PMI from the mortgage is by refinancing. The increased value of the property combined with the lower loan amount means you might own reach 80% of the home’s value faster. 

Consolidate your debts 

Refinancing your mortgage allows you to consolidate a lot of your debts into one monthly payment. Refinancing will allow you settle any outstanding debts you pay interest on like auto loans, student loans, or credits and just pay interest on one loan. 

So mortgage refinancing does offer a lot of benefits across a range of different circumstances. But that doesn't mean that it is without risks. 

The risks of mortgage refinancing 

Refinancing a mortgage will not reduce payments for every lender. Sometimes refinancing a mortgage can result in you paying more. The trick is knowing when you should refinance a mortgage. There are questions you should ask to ensure you don’t end up paying more. 

Is the mortgage rate lower now?

If you had a fixed-rate mortgage when rates were extremely low, it would be ill advised for you to refinance a mortgage when rates are high. Compare the current rates to the original mortgages rates to see if you would be paying more.

Has your credit score gotten worse? 

Refinancing your mortgage when your credit score has suffered is a bad idea. If your FICO score has dipped below 620 then you might struggle to find a lender that will refinance you. For every 20 points your credit score has lost, you can expect an increased mortgage rate. Often this means you will end up paying more. 

How is the term affected by switching mortgages?

You want to consider how the term of the mortgage is changing. If the term is getting longer, your monthly repayment will most probably be getting smaller, but the overall amount of interest you are paying is increasing. So this would mean you pay more in the long run. However, if you decrease the term, you may be paying more monthly, but could save on interest payments by paying up the principal faster.

What is the cost of refinancing a mortgage?

Refinancing a mortgage will come with a cost. It is important to work out what this cost is before switching mortgages. The closing cost will have a big impact on whether or not the refinancing is going to save you money in the end. The cost of closing a mortgage is usually 2-3% of the loan, although this does vary. The closing cost can be thousands of dollars, which is a big payout. You also need to look for any hidden fees before refinancing, and do the math to see if it will save you money. 

Types of mortgage refinancing  

There are three common types of mortgage refinancing. There is a benefit to each, depending on the reason for you switching mortgages. If you have a specific goal in mind, make sure your new mortgage is the best for your circumstances. 

Rate and term refinancing

Term and rate refinances are where the term of the mortgage, the rate of the mortgage or both changes. So a borrower might be switching from a 15-year mortgage to a 30-year mortgage, or they may switch to a lower APR (annual percentage rate). 

When using a no cash-out refinance mortgage, the closing costs of the mortgage can be added to the balance of the loan. This means that the homeowner has no costs to pay upfront. 

This is the refinance mortgage to use if you are just looking to lower your monthly payments, switching from an adjustable-rate mortgage to a fixed, or are looking to change the term of the loan. 

Cash-out refinance 

A cash-out refinance mortgage is when the new mortgage is bigger than the amount you owe against your home. So, for example you have paid off $100,000 on your current mortgage and only owe another $140,000. Instead of taking out a loan for $140,000 you increase the loan to $160,000. $140,000 of this loan is used to settle the previous mortgage. And the extra $20,000 is paid into your bank account. 

This type of refinancing is only really used when trying to consolidate debt, as the extra money is used to pay off creditors. Or when trying to consolidate a first and second mortgage so you only have one interest rate to pay. 

Cash-in refinance 

A cash-in refinance mortgage is the opposite of a cash-out mortgage refinancing. It is when you pay extra when closing a mortgage than you owe. This is usually done to bring down the amount loan-to-value rating on the property, so the lender can get better interest rates on their mortgage, or so the loan value is at 80% or less of the property’s value. This means the borrower can eliminate PMI and get better rates too. 

The switching mortgage advice here is very general. If you are unsure whether switching mortgages would beneficial, we'd advise you consult a mortgage adviser. They should be able to give you specific advice in context to your circumstances. To help you find an adviser, you can read our guide to the best mortgage lenders here.