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Explain Refinancing A Mortgage

Article by Mark Bennett

I am often asked to explain refinancing a mortgage. Why would you want to refinance? How does it benefit the home owner? And how does the process work?

We can explain refinancing a mortgage once you understand why there is so much interest in each monthly payment. The bank sets your monthly payment just high enough to cover the interest they want you to pay, plus just a very small amount extra. Only the extra goes toward reducing your loan principal – the amount you still owe.

The fact that it is just a small amount means that it will take you thirty years to pay back what you owe. Over the years, all those little amounts add up to reduce the amount you owe, so if you are partway through the thirty years, your outstanding balance will be lower than the original mortgage amount.

It may also be the case that interest rates are lower now than they were when you bought your house.

So, to explain, refinancing a mortgage allows you to take advantage of the changes over time. If you don’t do anything in particular, your mortgage payment will remain the same for thirty years, usually. Interest rates may change, but if you have a standard US 30 year mortgage, you will continue to pay the interest rate that was set the day you bought your house.

If you started over today, with a smaller principal amount and a lower rate of interest, then your monthly payment would be lower. Your bank won’t call you up and volunteer to do this, of course, because they want to keep taking interest from you at the higher rates from. You can’t count on your bank to explain refinancing a mortgage to you – why would they?

Refinancing your mortgage could lower your monthly mortgage payment. You can then use the extra cash each month to reduce your high-interest debts, over time getting out of debt completely. As you pay off each debt, you will have more extra cash each month, and in the end you can turn all that extra money each month towards paying off the mortgage itself, and become financially free.

To sum it up, it is easy to explain refinancing a mortgage, because in principle refinancing a mortgage is a simple concept. In practice, of course, there are many, many things to consider, and refinancing is not for everyone. You need to understand the options and how they apply to your circumstances before making a decision about mortgage refinancing.

 

Mark Bennett is a staff writer for Money Talks, and contributes regularly to other financial sites. This article is part of his series on refinancing, which can be seen at EmergencyRefinancing.com.

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