What Is Mortgage Refinancing? Should You Opt For It?

Home Loan

Let’s say you have opted for a mortgage loan of Rs. 40 lakh around 5 years ago. Now let’s consider, even though you have never missed any of your EMI payments, you have struggled to manage your financial liabilities or home loan EMI obligations all these years. In such a situation, you could opt for mortgage refinancing, meaning taking another mortgage or home loan to pay off your existing one.

Are you wondering how it works?  

Let us elaborate on its intricacies and the perks you get when you refinance your mortgage loan!

What is Mortgage Refinancing?

Mortgage refinancing means taking out a new mortgage loan to clear your existing home loan. Such a step can allow borrowers to take advantage of lower interest charges on offer from the other lender. 

Through mortgage refinancing, borrowers paying a higher EMI can lower their monthly liabilities.  

Mortgage Refinancing Example

One usually opts for mortgage refinancing to get a new loan with a lower interest rate which cuts down the repayment amount. Here is an example to understand how mortgage refinancing works:

Suppose you have availed of a home loan of Rs. 30 lakh in 2019. After repaying an amount of 8 lakh through EMIs, you have decided to opt for mortgage refinancing. 

At present, the outstanding amount on your home loan is Rs. 22 lakh. After doing relevant market research, you have found a new lender (Lender B) who is providing home loans at a lower interest rate than your current lender (Lender A). 

You can submit a mortgage refinancing application to Lender B, asking for Rs. 22 lakh as loan balance. After approval, Lender B will pay off your existing loan to Lender A. 

Going forward, you will be required to make the remaining EMI payments to Lender B to pay off Rs. 22 lakh. However, the new loan comes with a lower interest rate which will significantly impact your EMI. 

Benefits of Mortgage Refinancing

Apart from attractive interest rates, here are some additional features a mortgage loan refinancing facility comes with:

1. Long loan tenure

It’s true that choosing a longer repayment tenure means getting yourself into long-term commitments and contributing more towards interest payment. However, in the case of high-value loans, at times it could be necessary to go for a long loan tenure to reduce the EMI burden. This is one of the facilities you get when you refinance your mortgage loan.

2. Save more with low-interest rates

Mortgage refinancing involves applying for a mortgage loan, mostly with a different lender, at lower interest rates to clear your existing loan. Opting for refinancing could reduce your EMI burden due to a lower interest rate. This could help you save on interest payments that you were earlier paying against your existing mortgage loan.

3. Pay off your existing mortgage loan quickly

The primary reason to apply for mortgage refinancing is to close existing mortgage loans. You could be paying a higher interest rate on your existing loan, thus increasing your EMI burden. Refinancing would allow you to pay off your loan. Also, the EMI burden would be considerably less for your new mortgage loan. 

Types of Mortgage Refinancing

If you are thinking of refinancing your mortgage loans, you should know the different types to know which will be suitable for you. The following are the three primary types of mortgage refinancing options available:

• Rate-and-term refinancing: Under rate-and-term refinancing, the borrowers can make adjustments to the terms and conditions of the existing loan, such as interest rate or tenure. This can help individuals manage their mortgage loans when the financial market is going through turbulent times.
   
• Cash-out refinancing: Cash-out refinancing can prove to be beneficial for the borrower if he/she is in need of cash. 
  
  Suppose a borrower has a property with a home loan associated with it. He/she can apply for a new mortgage loan to pay off the outstanding amount on the home loan. This will pay off the previous loan, but it locks them into a new loan. The amount above and beyond the mortgage payoff is paid out in cash to the borrower. 

• Cash-in refinancing: Cash-in refinancing is the exact opposite of cash-out. This is an option for the borrower if a property’s market value drops below the outstanding loan amount. The borrower can repay some of the loan amounts and get another property loan of lower value. Then the borrower has to pay off a lower amount of mortgage loan with a lower interest rate. 

Also Read: Home Loan Tax Benefit Calculator 

How Does Mortgage Refinancing Work? 

This is the procedure every borrower has to go through to refinance a mortgage loan:

Step 1: One has to find a suitable lender who is offering a lower interest rate than the existing lender. 

Step 2: The borrower needs to discuss the loan requirement with the new lender. In this regard, lenders will ask for certain information, including property details. 

Step 3: To be able to enjoy the perks of a mortgage loan refinancing, individuals need to meet the necessary eligibility parameters. Only after that, lenders will decide on the loan amount and repayment terms.

Step 4: The new lender will verify all the property-related information and other details the borrower has provided. The loan disbursal takes a few days to complete if the borrower matches all required parameters. 

One should look out for penalty charges associated with this process before going ahead. Along with that, calculating the total charges applicable is also necessary to ensure that you are making substantial savings by availing of this facility. 

When Should You Opt for Mortgage Refinancing?

Some of the reasons how mortgage refinancing can help you have been discussed in detail: 

• Lower interest rate: This is the most common reason why borrowers opt for mortgage refinancing. Availability of a new loan at a lower interest rate to pay the outstanding amount of an existing loan will cut down the cost of EMIs and the whole repayment amount as well.
  
• Changing the type of interest payment: A borrower can switch from a loan with a fixed rate of interest to a loan with a floating interest rate and vice versa. If the borrower believes that he/she is stuck paying high EMIs because of a fixed interest rate, he can opt for a floating interest rate from a new lender.
   
• Additional loan: This is only possible if the property value has increased from the value for which the loan was availed against. 
  
  Suppose your property value was Rs. 30 lakh for which you availed a loan of Rs. 20 lakh. After 3 years, the outstanding amount has come down to Rs. 12 lakh. If the property value has risen considerably, say, up to Rs. 50 lakh, you can take out a new mortgage loan of Rs. 25 lakh against it. After paying the outstanding amount of Rs 12 lakh, you will still have incremental funding of Rs. 13 lakh at a lower rate of interest.

• Service of the existing lender: If the current lender is not providing quality service to you, you should do market research and look for another lender with better customer service. This can also offer you the benefit of availing better repayment terms.

Steps to Refinance a Mortgage

If you are considering refinancing your mortgage loan, you can go through the following steps: 

Step 1: Assess the reason why you want to opt for mortgage refinancing. (Is it to lower your interest rate or to pull out funds for repairs or debt repayment?)

Step 2: Getting approval for mortgage refinancing is similar to getting approvals for loans. Be sure to maintain a good credit score and have a stable financial history to get easy approval.

Step 3: Check the equity of your property. Equity is the difference between the current market value of the property and the outstanding loan amount. The higher the equity, the better the chances of getting loan refinancing at a lower rate of interest.

Step 4: Do your market research. Consider checking the additional or closing charges associated with mortgage refinancing. Also, it is advisable to decide the mode of repayment that will be accepted by the new lender. 

Step 5: Be ready for documentation. The paperwork is the most important step in the whole process. Collect all the documents as required by the lenders and also your tax returns and recent bank statements.

Step 6: Appraisal is the process of determining your property’s market value. Let the appraisers know if you have made any improvements to your home as this will add to the value of the property.

Step 7: Keeping an eye on the repayment is necessary, especially if you have opted for automatic payment. 

Disadvantages of Mortgage Refinancing 

Even though there are no such disadvantages of going for a mortgage, there are some aspects you should consider to maximise savings. One of these key aspects includes the residual tenure of your existing mortgage loan. 

Going for this facility during the later stages of the repayment tenure does not make sense as there will be no scope for interest cost savings. So, making such a decision towards the end of your loan tenure will inevitably be disadvantageous for you. 

Also Read: Why Should You Always Compare Home Loan Interest Rates?

How Does Refinancing a Mortgage Loan Impact Credit Score? 

As mentioned earlier, there are certain eligibility parameters lenders ask for when you approach them for a mortgage loan refinancing. One of those criteria includes the credit score. Having a clean repayment track record and a high credit score automatically increases the chance of getting low-interest rates. 

However, you must know that multiple inquiries regarding the CIBIL score generally have a negative impact on it. As per financial advisors’ recommendations, you should not approach way too many financiers at the same time. 

That said, the mortgage refinancing facility enables borrowers to increase their credit score. With reduced EMIs, it becomes easier to repay loans on time. This automatically improves the credit profile.  

Things to Consider before Opting for Mortgage Refinancing

You should consider the following points before opting for mortgage refinancing:

• Check your credit score
• Know your equity portion in that property
• Be aware of your debt-to-income ratio
• Additional charges associated with refinancing
• Adjustment between the rate of interest and repayment tenure

Final Word 

There are some other ways to reduce your equated monthly instalment amount, such as negotiating for a lower interest rate and restructuring the loan with the current lender. However, when you go for mortgage refinancing, you could get a top-up loan facility as well. Due to its no end-use restrictions feature, you can utilise these funds to meet any kind of financial requirement.

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FAQs on Mortgage Loan Refinancing

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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.