Refinancing refers to the replacement of an existing debt obligation with a debt obligation under different terms. The most common consumer refinancing is for a home mortgage A mortgage loan is a loan secured by real property through the use of a document which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan. However, the word mortgage alone, in everyday usage, is most often used to mean mortgage loan.
If the replacement of debt occurs under financial distress Financial distress is a term in Corporate Finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. Sometimes financial distress can lead to bankruptcy. Financial distress is usually associated with some costs to the company; these are known as costs of financial distress, it is also referred to as debt restructuring Debt restructuring is a process that allows a private or public company – or a sovereign entity – facing cash flow problems and financial distress, to reduce and renegotiate its delinquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations.
A loan (debt) can be refinanced for various reasons:
- To take advantage of a better interest rate (which will result in either a reduced monthly payment or a reduced term)
- To consolidate other debt(s) into one loan (this will result in a longer term)
- To reduce the monthly repayment amount (this will result in a longer term)
- To reduce or alter risk (e.g. switching from a variable-rate to a fixed-rate loan)
- To free up cash (this will result in a longer term)
Refinancing for reasons 2, 3, and 5 is usually undertaken by borrowers who are in financial difficulty in order to reduce their monthly repayment obligations, with the penalty that they will remain in debt for years longer.
In the context of personal (as opposed to corporate) finance, refinancing multiple debts makes management of the debt easier. If high-interest debt, such as credit card A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services. The issuer of the card grants a line of credit to the consumer from which the user can borrow money for payment to a merchant or as a cash advance to the debt, is consolidated into the home mortgage, the borrower is able to pay off the remaining debt at mortgage rates over a longer period.
For home mortgages in the United States, there may be tax advantages available with refinancing, particularly if one does not pay Alternative Minimum Tax Alternative Minimum Tax is part of the Federal income tax system of the United States. There is an AMT for those who owe personal income tax, and another for corporations owing corporate income tax. Only the AMT for those owing personal income tax is described here.
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Risks
Most fixed-term loans have penalty clauses ("call provisions") that are triggered by an early repayment A payment is the transfer of wealth from one party to another. A payment is usually made in exchange for the provision of goods, services or both, or to fulfill a legal obligation of the loan, in part or in full, as well as "closing" fees. There will also be transaction fees on the refinancing. These fees must be calculated before embarking on a loan refinancing, as they can wipe out any savings generated through refinancing.
If the refinanced loan has lower monthly repayments or consolidates other debts for the same repayment, it will result in a larger total interest cost In business, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In economics, a cost is an alternative that is given up as a result of a decision. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is over the life of the loan, and will result in the borrower remaining in debt for many more years. Calculating the up-front, ongoing, and potentially variable costs of refinancing is an important part of the decision on whether or not to refinance.
In some jurisdictions, varying by American state, refinanced mortgage loans are considered recourse debt Recourse debt is a debt that is not backed by collateral from the borrower. Also known as a recourse loan, this type of debt allows the lender to collect from the debtor and the debtor's assets in the case of default as opposed to foreclosing on a particular property or asset as with a home loan or auto loan. Nonpayment of recourse debt allows the, meaning that the borrower is liable in case of default, while un-refinanced mortgages are non-recourse debt Nonrecourse debt or a nonrecourse loan is a secured loan that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the collateral. If the property is insufficient to cover the.
Points
Main article: Point (mortgage) Points, sometimes also called a "discount point", are a form of pre-paid interest. One point equals one percent of the loan amount. By charging a borrower points, a lender effectively increases the yield on the loan above the amount of the stated interest rate. Borrowers can offer to pay a lender points as a method to reduce the interestRefinancing lenders often require a percentage of the total loan amount as an upfront payment. Typically, this amount is expressed in "points" (or "premiums"). 1 point = 1% of the total loan amount. More points (i.e. a larger upfront payment) will usually result in a lower interest rate. Some lenders will offer to finance parts of the loan themselves, thus generating so-called "negative points" (i.e. discounts).
Types (US loans only)
No Closing Cost
Borrowers with this type of refinancing typically pay few upfront fees to get the new mortgage loan.[citation needed] This type of refinance can be beneficial provided the prevailing market rate is lower than the borrower's existing rate by at least 1.5 percentage points.[citation needed]
However, what most lenders fail to disclose is that the money a borrower save upfront is being collected on the back end through what's called yield spread premium A “yield spread premium” is the money or rebate paid to a mortgage broker for giving a borrower a higher interest rate on a loan in exchange for lower up front costs, generally paid in Origination Fees, Broker Fees or Discount Points. This “may [be used to] wipe out or offset other loan costs, like Loan Level Pricing Adjustments (institutend (YSP). Yield spread premiums are the cash that a mortgage company receives for steering a borrower into a home loan with a higher interest rate. The latter will even eventually lead to borrowers overpaying.
True No Closing Cost mortgages are usually not the best options. When the borrower pays out of pocket for their closing costs, they are better able to understand all the costs associated with the loan. In most cases, the borrower is also able to negotiate the fees for the appraisal and escrows down to a reasonable cost. Sometimes, when wrapping closing costs into a loan, borrowers forget about the fees because they are usually not coming into the loan with any money.
Cash-Out
This type of refinance may not help lower the monthly payment or shorten mortgage periods. It can be used for home improvement, credit cards, and other debt consolidation Debt consolidation entails taking out one loan to pay off many others. This is often done to secure a lower interest rate, secure a fixed interest rate or for the convenience of servicing only one loan if the borrower qualifies with their current home equity; they can refinance with a loan amount larger than their current mortgage and keep the cash difference.
See also
- Refinancing risk In banking and finance, refinancing risk is the possibility that a borrower cannot refinance by borrowing to repay existing debt. Many types of commercial lending incorporate bullet payments at the point of final maturity; often, the intention or assumption is that the borrower take out a new loan to pay the existing lenders
- Refunding Refunding occurs when an entity that has issued callable bonds calls those debt securities from the debt holders with the express purpose of reissuing new debt at a lower coupon rate. In essence, the issue of new, lower-interest debt allows the company to prematurely refund the older, higher-interest debt
References
External links
- U.S. Department of Housing and Urban Development - Streamlining your Mortgage
- U.S. Department of Veteran's Affairs - Mortgage Refinancing Information
- Good Neighbor Next Door - FHA Good Neighbor Next Door
- Indian Home Loan Guarantee Program - Indian Home Loan Guarantee Program
- HUD - Information about HUD
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Sun, 22 Aug 2010 23:13:12 GMT+00:00
cbs4denver.com To refinance homeowners need to know qualifications are tougher. Credit scores need to be 720 or higher; income requirements generally mean that monthly ...
