Refinancing you home can be an excellent way of reducing your monthly costs, reduce the interest you pay and payoff your mortgage sooner. It also can be a complete waste of money; where the only ones who benefit are your bank’s shareholders.

Refinancing a home is completely different to modifying a loan, another popular measure with struggling borrowers since the mortgage crisis that began in 2008. While a loan modification varies the terms of a loan by reducing interest rates, extending the loan term or even reducing the loan principal; a mortgage refinance pays off the old loan in full with the money borrowed from a new loan. The new loan can be bought off the same bank or another bank that offers a better deal. Loan modifications are for borrowers that cannot afford to pay their mortgage and are behind in their payments. Mortgage refinancing is for borrowers that can afford their mortgages and are up-to-date with their payments, but want to take advantage of better loan terms.

So, what are the factors that determine if refinancing is a good idea, as opposed to a loan modification, paying off the loan with savings, or just staying as you are?  There are several; we will focus on four: 1) the balance of your mortgage, 2) the interest rate reduction, 3) the cost of refinancing, and 4) the term of the new loan.

Each of these factors will determine if refinancing your mortgage is a good idea or not. Let us look at each factor separately, and learn how to use the information to work out the profitability (or not) of a mortgage refinance. Once we understand the concepts we will need to use a mortgage refinance calculator to decide what a refinance is going to cost us or save us.

Refinancing a loan can save you money if the new loan has lower interest rates, has a shorter loan term, or provides you with better loan terms like a fixed interest rate instead of variable. As mentioned above although refinancing has the potential to save you money it can also be an expensive operation that only benefits the bank. To work out the

1)      The balance of your mortgage.

Refinancing a mortgage only makes sense if you have a large balance on your current mortgage. If you are close to paying off your mortgage the cost of refinancing your loan is likely to outweigh the savings. However, if you are planning to increase your current mortgage balance with the refinance loan to consolidate other loans, buy a yacht or simply top up your income for retirement, it could make financial sense.

2)      The interest rate reduction.

The interest rate reduction is the difference between the old interest rate and the new interest rate. Even a difference of 1% can create huge savings throughout the lifetime of the loan. Interest rates have dropped considerably; if your mortgage is over two years old the chances are you could save a lot if you refinanced your mortgage with the current interest rates.

Continue reading the second section of this article and learn how to calculate if a refinance is worth your time and money.

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