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Mortgage Refinancing: Evaluating Loan Types

Karen Lawson
LoanBiz Columnist

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Homeowners who want to refinance their mortgage loans have a wide variety of options. Mortgage lenders provide free online mortgage calculator tools to help compare and contrast features and benefits of mortgage loans. Using these calculators can help identify which mortgage loans meet specific circumstances. Here are a few examples of how refinancing can help in a variety of circumstances.

Adjustable rate mortgage (ARM) to fixed rate mortgage FRM

The most popular option for refinancing is to refinance an ARM to an FRM to stabilize principle and interest (P&I) payments and/or eliminate non-standard features such as negative amortization. This type of refinancing does not impact changes in property taxes, hazard insurance, or mortgage insurance payments, so this portion of a mortgage payment can continue to change each year.

Negative amortization to standard amortization

Option ARM loans allow borrowers to make very low payments that don't cover the actual interest owned. The unpaid interest is then added to the mortgage balance. This is called negative amortization, and eventually payments can increase sharply in order to repay the loan. A mortgage with negative amortization can be useful in helping homebuyers who need a very low initial payment. Once the homeowners can afford a higher payment they may want to refinance to a fully amortizing mortgage for stability.

Understanding prepayment penalties is important when shopping for a mortgage loan. A prepayment penalty is assessed if a mortgage is paid off or refinanced within a certain time period. Usually the lender offers borrowers more favorable rates if they accept a prepayment penalty.  Reading and understanding mortgage disclosure statements before accepting a mortgage loan can help avoid problems later.

Debt Consolidation / Cash-out refinancing

Credit card balances and other consumer debts can quickly add up. Card companies may charge high interest rates, late fees and other charges that can make paying off consumer accounts very difficult. It may be possible to pay off high cost debts with cash-out refinancing. This option means replacing an existing mortgage with a bigger loan, and the difference (cash out) is used to pay off other debts. Mortgage calculator tools can help estimate P & I payment amounts, and affordability based on monthly income and expenses.

How to Shop

Federal disclosure laws require lenders to provide home mortgage disclosure statements that show all terms such as payment due dates, interest rates, interest rate change dates, and the total cost of financing. Ask lenders to provide estimates of closing costs associated with refinancing. It's a good idea to have a list of questions and to take notes when speaking with mortgage lenders.  As with any major financial transaction, it's a good idea to consult a financial advisor or tax professional to assist in identifying appropriate refinancing options.


About the Author
Karen Lawson is a freelance writer with more than fifteen years of experience in mortgage banking. She holds BA and MA degrees in English from the University of Nevada, Reno

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