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What You Should Know Before Refinancing

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Getting a new mortgage to replace the original is called refinancing. Refinancing is done to allow a borrower to obtain a different and even better interest term and rate. The first loan is paid off, allowing the second loan to be created, instead of simply making a new mortgage and throwing out the original mortgage. For borrowers with a perfect credit history, refinancing can be a good way to convert a variable loan rate to a fixed, and obtain a lower interest rate. Borrowers with less than perfect, or even bad credit, or too much debt, refinancing can be risky.

In any economic climate, it can be difficult to make the payments on a home mortgage. Between possible high interest rates and an unstable economy, making mortgage payments may become tougher than you ever expected. Should you find yourself in this situation, it might be time to consider refinancing. The danger in refinancing lies in ignorance. Without the right knowledge it can actually hurt you to refinance, increasing your interest rate rather than lowering it. Below you will find some of this basic knowledge written in order to help you reach your best deal. If you're like most, you've never made a dime off your dwelling (aside from appreciation) even though your house and yard likely represent your single largest asset.

What is Refinancing?

Refinancing is the process of obtaining a new mortgage in an effort to reduce monthly payments, lower your interest rates, take cash out of your home for large purchases, or change mortgage companies. Most people refinance when they have equity on their home, which is the difference between the amount owed to the mortgage company and the worth of the home

What are the Advantages of Refinancing?

One of the main advantages of refinancing regardless of equity is reducing an interest rate. Often, as people work through their careers and continue to make more money they are able to pay all their bills on time and thus increase their credit score. With this increase in credit comes the ability to procure loans at lower rates, and therefore many people refinance with their mortgage companies for this reason. A lower interest rate can have a profound effect on monthly payments, potentially saving you hundreds of dollars a year.

What are the Risks?

The first thing you must do when considering refinancing is to consider exactly how you will repay the loan. If the home equity line of credit is to be used for home renovations in order to increase the value of the house, you may consider this increased revenue upon the sale of the house to be the way in which you will repay the loan. On the other hand, if the credit is going to be used for something else, like a new car, education, or to pay down credit card debt, it is best to sit down and put to paper exactly how you will repay the loan. 
Also, you will need to contact your mortgage company and discuss the options available to you, as well as discussing with other mortgage companies the options they would make available. It may be that there is not a current deal which can be met through refinancing that would benefit you at the moment. If that is the case, at least you now know exactly what you must do in order to let a refinancing opportunity best benefit you. When refinancing, it can also benefit you to hire an attorney to decipher the meaning of some of the more complicated paperwork.

Second, many people refinance in order to obtain money for large purchases such as cars or to reduce credit card debt. The way they do this is by refinancing for the purpose of taking equity out of the home. A home equity line of credit is calculated as follows. First, the home is appraised. Second, the lender determines how much of a percentage of that appraisal they are willing to loan. Finally, the balance owed on the original mortgage is subtracted. After that money is used to pay off the original mortgage, the remaining balance is loaned to the homeowner. Many people improve upon the condition of a home after they buy it. As such, they increase the value of the home. By doing so while making payments on a mortgage, these people are able to take out substantial home equity lines of credit as the difference between the appraised value of their home increases and the balance owed on a mortgage decreases.

What's up with that? You've got tons of extra space in that spare bedroom, garage or basement that you're already heating, cooling and paying taxes on. And don't forget that idle front yard and backyard.

Why not make the old homestead earn its keep?

"There's something very positive to be said for becoming self-sufficient through assets you already own," says Katina Z. Jones, author of "The 200 Best Home Businesses." "With gas prices being what they are these days, there's a huge financial advantage to keeping your overhead low with a home-based source of income. The tax deductions associated with operating a business from home help on the back end as well."
"Every dollar you can cut in expenses is a dollar you don't have to bring in. The need for extra income right now is so severe," she says.
Of course, local ordinances and homeowner association rules may prohibit or restrict your home moneymaking plans.
Always check first with local authorities, and be sure to ask about licenses, fees and other requirements. And whatever you do, don't forget to report your earnings on your income tax return.