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TERMINOLOGY

Switching out of your current mortgage loan to a different one can be a very smart financial decision. There are several common reasons why homeowners will refinance, or switch their loans for new ones.

Switch to a Lower Interest Rate
Perhaps the most common reason people refinance is to take advantage of lower market interest rates. If you bought a house during a period of high interest rates, you can lower your monthly mortgage payment by switching to a new loan when rates fall significantly below your current rate. Be aware, though, that loan closing costs and points can quickly eat into the savings. Plus, if you refinance at a lower rate, but stretch out the term to 30 years again, you may end up paying more in interest over the life of your loan.

Switch from an ARM to Fixed Rate Loan
Adjustable rate mortgages have fallen in and out of favor and popularity in the past few decades. No matter what the prevailing consumer sentiment about them, they always carry more risk than a fixed rate loan. After the initial low rate period is over, the interest rate is allowed to adjust higher or lower. When it rises high, the payments can become unmanageable. Switching to a fixed rate mortgage removes the risk of “payment shock” by requiring a consistent payment each month, although the overall costs may be more in the long run again.

Switch to a Longer Term
Another way to make payments easier to swallow, when that is the goal, is to refinance into a longer term. That might mean simply getting a new 30 year mortgage. Some lenders, however, offer 40 year loans that can significantly reduce the monthly amount due, allowing some at-risk borrowers to stay in their homes.

Switch out Equity for Debt Consolidation
Homeowners who have built up a decent amount of equity in their homes often refinance their mortgages in order to cash out some of that investment for other purposes, like debt consolidation. A cash-out refinance is a new loan that carries a higher balance than the current loan and the excess can be used by the borrower for anything he or she wants. While this option will allow homeowners to pay for other financial projects, it will not decrease the costs of a mortgage.

If you need help determining if a refinanced loan is a wise move for you, check out our Mortgage101 Refinance Calculator.