Thursday, June 10, 2004

Risks of a Refinance

Refinancing an existing loan usually offers borrowers a number of advantages. For example, lenders generally offer refinanced loans at a lower, fixed interest rate and a longer term. Consequently, the borrower pays a lower monthly payment and saves money. The borrower must be cautious, however, as refinancing also carries certain risks.

Closing Costs and Penalties

    The title insurance fee, title search fee and appraisal fee are just a few of the possible closing costs associated with refinancing. The lender will normally negotiate the application fee, loan origination fee and discount points, contingent on the borrower's credit score. Some refinanced loans also carry penalties for early repayment. The borrower must consider all of these fees and penalties before venturing into refinancing, as they may reduce or eliminate the savings offered by the refinance.

Increased Interest Costs

    The lower monthly payments available through refinancing typically result in increased interest costs over the life of the loan. This could keep the borrower in debt for a number of additional years. Therefore, the borrower must calculate this potential ongoing variable cost when deciding whether or not to refinance.

Adjustable Interest Rates

    Adjustable interest-rate loans, such as 2/28 loans or 5/25 loans, are a definite risk when opting for a refinance. In a 2/28 loan, the lender offers a lower interest rate for the first two years of a 30-year loan. After this initial period, the interest rate will fluctuate every year for the next 28 years, depending on the market index. The adjusted interest rate may result in a monthly payment that you can't afford.

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