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June 2002

A lot of people try to deal with debt by refinancing their loans. Refinancing means paying an old debt with a new debt. Sometimes that makes sense because your total cost of borrowing money may be less. Refinancing may look good now when interest rates are lower than they have been in years. However, smaller monthly payments do not always mean that refinancing will be a good deal for you as a consumer. This article takes a general look at this topic and gives some tips to protect yourself.

Loan Basics
It is important to know some money basics about loans.

• Principle  Principle is the money you borrow. If you borrow $100.00, the principle is $100.00.
• Interest   Interest is what you pay to borrow the money. Suppose you borrow $100.00 for one year and the interest is 10%. When you repay the loan, the actual cost of the money to you is $110.00. You paid $10.00 in interest, or ten cents for each dollar of the loan. A lender will tell you what the interest is by giving you the annual percentage rate (A.P.R.). The A.P.R. for the loan in this example is 10%.
• Collateral  There are two kinds of loans: unsecured and secured. An “unsecured” loan is when the lender trusts you to pay back the money without some property  in exchange for the loan. An example of an unsecured loan is a credit card. A “secured” loan means you have something the lender can take away if you do not pay the money back. Collateral is the property that secures the loan. An example of a secured loan is a car loan. If you do not keep up with the payments you agreed to make, the lender will take the car back. The car “secures” the loan and is called collateral. Changing from an unsecured to a secured loan may save you money, but it could put the property you are now using as security at risk. If you can’t make the new payments, the lender can come after that property.
• Mortgage A mortgage is a loan that is secured by land. There are two kinds of mortgages. A closed-end mortgage does not let you borrow more money using the same collateral. The money you borrowed is all you can borrow on that mortgage. An open-end mortgage lets you borrow more money on the loan after some of it is paid.

Should You Refinance Your Home Mortgage?
Interest rates for home mortgages are a lot lower now compared to the rates many people paid when they bought their homes. Whether or not refinancing would be good for you depends on several factors. Look at the interest on the loan you have now. It is good to pay lower interest because you are paying less for the loan. But don’t refinance just because the interest rate on the new loan is lower.

Other fees are involved in getting a new loan, which you must think about to see if refinancing will be a good deal. You do not want to refinance if you won’t save money. Most of the time you will save money if the new interest rate is at least 2% lower than the one you have now. Suppose your interest rate now is 10%. If the new interest rate is 9% you should not refinance. If you do not know the interest of your current loan, call the lender to find out.

One of the charges in refinancing is known as “points.” A point is one per cent of the principle for the amount borrowed. When you look at interest rates, be sure to ask about points. The points are a cost you pay in addition to the loan and its interest. An 8% rate with two points costs more than an 8% rate with zero points. To find the points on the new loan, call the company from which you want to borrow.

Something else to think about is how long you will live in the house. If you plan to move again soon, you might end up paying the costs but not getting the benefits of a lower-rate loan. It usually takes at least three years to see the savings from refinancing.
It can take up to two months or more before you can get the loan. The interest rates can change while you wait. To protect yourself against an increase in the rate, ask about a free “lock-in.”  A lock-in means that your interest stays the same as you wait to get the loan. The other side of the coin is that rates might go down after a lock-in, which would mean you will have the higher rate for your loan. Make sure getting a lock-in is free. Sometimes, the lender might say it is free but it isn’t. If you want to make sure it is free, get it in writing.

Ask about fees. Plan on spending 3% to 6% of the principle for an extra refinancing cost. Some lenders have no application costs. If the lender does not have extra costs when you apply, make sure they will not charge a lot of fees when you close on the loan. Make sure that you don’t have to pay extra if you pay off your current loan early.

Do not be afraid to stand up for yourself. Tell the lender “no” if you are not comfortable. Do not let someone talk you into a loan you don’t want or need. It is a good idea to get things in writing. Make sure you understand anything that you sign.

Your Rights if You Refinance
The law defines refinancing as paying one loan by getting a new loan. When you get the new loan, the law says that the lender must give you information about the loan. You have a right to know who is lending you the money.

For most commercial lenders, there are several things that the lender has to tell you. The lender has to tell you how much you are borrowing. This is called the “amount financed.”  The lender has to tell you that you have the right to ask for an itemization of the amount financed. The itemization is a list of what is in the amount financed. If you ask for the itemization, you have to put your request in writing.

You have a right to know the “finance charge.”  This is how much you are paying to borrow the money. This includes the fees the lender charges for you to borrow money (like a processing fee and application fee). It also includes the interest. The finance charge is not itemized but the lender has to tell you the A.P.R. (annual percentage rate).

You have a right to know the “total of payments.” The total of payments is the amount financed plus the finance charge. The lender should tell you how many payments you need to make. The lender needs to tell you how much each payment is and when you have to pay it. The contract has to explain what “amount financed,” “finance charge,” “annual percentage rate,” “total of payments” and “total sale price” means.
The contract has to say what the collateral is. You have the right to know how much you have to pay if you are late on a payment. The contract also needs to say if someone else can take over the loan for the lender, if you have to pay extra to pay off the loan early.

Conclusion
You may be able to lower the total amount of money you owe by refinancing. Before you refinance, make sure that over time it will save you money. If you do refinance, make sure that the lender tells you what you have a right to know.