Key Factors to Consider Before Refinancing a Loan
In 2020, the coronavirus pandemic caused a worldwide economic collapse. While nations have slowly been recovering these past few months, many individuals and small businesses remain financially challenged.
The health crisis especially affected everyday consumers who have mortgages or other loans to pay off, as staying afloat while making repayments can be difficult. One way to make the load lighter is to refinance.
Refinancing Home, Auto, or Business Loans
Real estate owners have a great chance to reduce their interest rates and monthly payments by refinancing their pre-pandemic mortgages. In fact, research shows that mortgage rates in the Philippine residential market have recently decreased from 20%-30% to 6%-8% amid the Asian financial crisis.
Apart from real estate mortgages, car refinancing also presents a good opportunity to lower interest rates and monthly payments. Not to mention, it may even allow borrowers to change the length of their auto loan.
As for business loans, the Bangko Sentral ng Pilipinas (BSP) has been carrying out new policies to counter the economic decline brought by the global pandemic. As a result, business loan interest rates are at a record low, making it an ideal opportunity to refinance current loans.
If you’re still debating whether or not to refinance a home, car, or business loan, we will discuss some advantages and disadvantages that may help you reach a decision. But before we dive deeper, let’s briefly tackle how refinancing works.
What is refinancing?
Refinancing is the process of repaying an existing loan and replacing it with another in the hopes of getting a lower interest rate and a longer or shorter loan term. For instance, a borrower can switch from a 15-year to a 30-year term, making it much easier and less burdensome to pay off the loan.
Refinancing can also allow you to reduce your monthly installments, save money on interest throughout the entire loan duration, change your payment schedules, pay off your mortgage faster, and access the equity in your real property in case you need the money.
Loan refinancing works similarly to a typical mortgage application. A lender will examine your finances to evaluate the number of risks and your qualifications to offer you the best interest rate. It’s a completely new loan and it could come from a different lender than the one who provided your initial loan.
Types of Refinance Loans
There’s an assortment of refinance loans available, so it’s essential to choose the type that best suits your current financial situation and ability to pay.
1. Loans with fixed rates
The fixed-rate term loan has a defined amount of interest rate and monthly payments. If you wish to remain in your house for at least seven years, this could be a suitable option for refinancing a mortgage.
2. Loans with variable interest rates
Monthly payments on adjustable-rate loans fluctuate as interest rates also increase and decrease. In the short term, adjustable-rate loans have lower interest rates than fixed-rate loans, but because these are volatile, you can’t determine how much your loan repayments will be in the future.
3. Loans with cash out
Cash-out refinanced loans allow homeowners who had built up equity in their houses to refinance and borrow against that equity. This gives you a quick, tax-free income that you can spend in any way you see fit.
When to Refinance
Generally, refinancing is considered a wise decision if it is beneficial to your financial situation. This will be largely determined by your objectives. For example, do you want a smaller monthly payment? Are you trying to save money on the total amount of interest paid? Do you need to get money out of your property using the equity you’ve built up?
Here are four factors to consider before refinancing.
1. Mortgage rates have decreased
Mortgage interest rates for homeowners can shift due to a variety of factors such as market fluctuations, inflation, and global concerns like pandemics. If mortgage interest rates drop, you may be able to secure a better interest rate than you currently have on your loan.
However, how much should mortgage interest rates fall before deciding whether refinancing is worthwhile? A good rule of thumb is to restructure if the interest rates are at least 1%-2% lower than your current rate. When considering refinancing, always keep your existing loan term in mind.
2. Your credit score has improved
Your credit score plays a key role in deciding your mortgage rate. In general, the better your credit, the lower the interest rate you’ll get.
3. You prefer a loan with a shorter repayment period
If you want to pay off your debts more quickly, you should consider refinancing your mortgages to a shorter loan term. If you can get a cheaper interest rate while simultaneously reducing your term, you may be able to increase your savings. Also, with a shorter loan period, you will pay less interest overall.
4. Your home’s value has increased
If the value of your property has grown, refinancing may provide some advantage, particularly if you have other high-interest loans to pay off or other investment goals you want to pursue.
A cash-out refinance allows you to take out a higher mortgage than the one you had before, and the difference will be given to you in cash. However, you must be careful not to pay more in mortgage interest than you would on whatever expenses you are using the difference for.
5. You can use your equity for more urgent expenses
Again, refinancing can be utilized to free up equity in your real property to finance high-priority purchases. Getting access to equity, for instance, can fund a home renovation or a child’s school fees. The amount of equity you will be allowed to use varies by lender, so seeking the guidance of a mortgage expert can be helpful.
6. You can consolidate debts
Refinancing your loan can also provide an opportunity for you to consolidate your debts and, perhaps, reduce the total interest you’re paying on several loans. It entails consolidating many high-interest debts into a single lower-interest debt, which can be your home or car loan and can result in lower monthly payments overall.
When Not to Refinance
1. The costs of refinancing nullify the savings
It’s crucial to keep in mind that there are costs involved in refinancing. If their total amount is significant enough, they could easily offset your potential savings.
Refinancing typically includes closing expenses, which can help you decide whether or not getting a new loan is beneficial for you. These fees can range between 2% and 5% of the amount refinanced, so do the calculations before making a decision.
2. The savings may not be worth the amount of work
As explained above, the savings from a refinance may be insignificant compared to its costs. In addition, you should consider if the amount of savings is worth the effort put into refinancing your existing loan.
Remember, the refinancing process is long and tedious. Even if everything goes smoothly, you will still need to follow multiple steps, such as applying for a new loan, submitting the required paperwork, and getting a professional appraisal done.
3. The equity in your home may decrease
A cash-out refinance will enable you to borrow against your property’s equity. However, that means using the equity in your home, which can drastically lower its value. If you want to have substantial equity left, a cash-out refinance may not be the right option for you.
4. Monthly payments can still elevate
Please note that refinancing is subject to repricing and fixed rates. Moreover, most Philippine banks offer fixed pricing durations for up to 20 years.
If you decide to refinance from a 20-year mortgage to a 10-year one, your payment can significantly increase since you are lessening the amount of time you have to repay the loan.
Will refinancing hurt your credit?
Mortgage refinancing can influence your credit, but the effect is unlikely to be noteworthy. For instance, to determine if you are eligible for a refinance, mortgage lenders run a credit check, which reflects on your credit file. A single question can deduct several points from your overall score.
Whenever you refinance, you close one loan and open a new one. Because your credit history accounts for 15% of your score, having one loan shut and then starting a new one slows down the term, which affects your score.
Generally, these effects will be felt only for a brief time. If you’re worried about damaging your credit when comparing refinance offers, try to look for loans inside a 45-day window. Any credit pulls linked to your refinance during this time will be counted only as a single inquiry.
The Key Takeaway
Refinancing can be a smart financial decision, but it all depends on your situation and goals. Furthermore, refinancing takes considerable time and effort, so determine whether the savings you can earn are worth all the extra work.
However, the chance to save money by acquiring a better interest rate and minimizing your monthly repayments can be too good to pass up. Therefore, if it suits your situation, taking advantage of lower interest rates will likely benefit you in the long term.