How does a mortgage refinance work?

Having information on how refinancing works can stand you in good stead should you ever wish to take advantage of low interest rates and refinance an existing mortgage. And in order to understand how the facts and figures related to mortgage refinancing work, you can download a mortgage refinance calculator at the end of this post. A refinance is often termed debt restructuring.

Basically, a refinancing implies replacing an existing mortgage debt with another one that has new terms and conditions that you are more comfortable with. Your old loan is paid off by the new lender that grants you the refinance. A refinance lets you take advantage of lower interest rates, consolidate high interest loans or get cash out of your equity in your property. You can also refinance a variable rate loan into a fixed interest loan and eliminate the risk associated with adjustable rate loans.

Before considering a refinance on your existing mortgage, calculate and see if there are any true savings once you have paid the penalty for early loan payment plus the costs of transactions and closing cost. Decide upon a refinance only after finding out the upfront, ongoing, and potential costs over the life of the loan.

Alternatives to a mortgage refinance include a home equity line of credit or a second mortgage.
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Yes, a mortgage refinance qualifies for tax credit; in fact it is one of the couple of other tax breaks that you can get if you are refinancing an existing mortgage. The tax breaks revolve around you paying “points” with the closing costs of your first mortgage. A point equals one percent of the total loan amount and is also termed loan discount or origination fee.

A first mortgage on your primary residence will let you enjoy deductions on the points in the very year that they are paid. However, when you refinance a mortgage loan you are allowed to avail deductions of the life of the term of the new mortgage. Then again, if you feel that the rates have fallen down and you wish to refinance again you may be eligible to get a full deduction on the unamortized amount carried over from the earlier refinance.

The IRS sets certain conditions for the deduction of unamortized points. So, if you choose to go for a refinance with the same lender then you cannot get a deduction in the same year, it has to be over the term of the refinance loan. Refinancing with the same lender is not a very common happening, it occurs only 20% of the time.

A very obvious benefit of a refinance is the lower interest rate. If you use your refinance amount to pay off the earlier mortgage and also for home improvement then the percentage of the mortgage value used for home improvement acts as a base for calculating the percentage of points that attract a tax credit.

An important thing to remember is that you will enjoy tax breaks only on your primary residence and not vacation homes. If it is a second home then you have no option but to have the points amortized over the term of the loan.

If you pay off your mortgage early you will be able to deduct any unamortized points in the year you pay off the mortgage. However, if there is a penalty for early repayment then that fee is deducted. Similarly, late payment fees are also deductible.

Here are some good points on tax deduction and refinance.