My parents recently suggested I refinance my home to help with some of my debt, but how does that help/work?
I bought my house in 2020 for roughly 275,000 its current market value is close to 400,000. From my understanding I can use the difference in value to help pay for the loan, but how exactly does that work? And how do I go about it?
In: Economics
Refinancing is basically taking a new loan (mortgage) to pay off your old loan. There is nothing particularly special about it – go to a bank or credit union and talk to a loan officer. The process is pretty much identical to the original mortgage.
There are several (relatively good) reasons to do this.
a) Interest rates have fallen and you can refinance basically the same amount and pay less interest. Mortgage loans have pretty high up front fees so the interest rate savings would need to be substantial for this to really make sense. Be careful because lots of banks try to attract the borrower by “LOWER YOUR MONTHLY PAYMENT” but hide the fees in the new loan – meaning the borrower ends up paying A LOT MORE in the long run. Shop around and make sure you’re getting a good deal.
b) Changing terms of loan. You might have a variable rate loan and want to switch to a fixed rate loan (not available in all countries) or vice versa. You want to change the term of your loan say you have 20 more years on the current loan and want to reduce it to 15 years or vice versa.
c) The home price has appreciated and you want to take out a bigger loan and get some cash on hand. Say your loan outstanding is 150K and your house has appreciated enough so that the bank will be willing to lend you 200K, you take 150K to pay off the existing loan and keep 50K in cash. (of course your monthly payments might also go up). Not a great idea unless you are disciplined and use that cash wisely. (maybe medical expenses, kid’s education or investment etc. Blowing it on a holiday or new expensive car would be a bad idea generally)
d) Tax optimization. In the US, for example, mortgage interest is deductible from income for primary residence (up to 750K loan – married joint filing) This can be beneficial for people who have high salaries and are in a high marginal tax bracket. But see a tax specialist – this gets complicated.
e) A variant of (c). Debt consolidation. If you have existing other debt like car loans, credit card debt etc which tend to have higher interest rates and also not interest deductible, refinance to pay off all the other debt. Mortgages tend to have lower interest rates and result in reduced total monthly payments.
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