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A refinance is the process of paying off one loan with the proceeds from a new loan using the same property as the collateral. The difference between a purchase money loan and refinance (refi loan: pronounced "reefye") is basically their purpose. A purchase money loan is used to purchase a home whereas a refinance is used to pay off an existing mortgage. Otherwise, there really is not any difference between in how they work. In terms of principal, interest,loan term, and amortization, and security instruments, both types of loans are identical. The advantages and disadvantages of getting a fixed rate mortgage vs. an adjustable-rate mortgage, or a short term vs. a long term loan apply pretty equally to both a home purchase loan and a refinance loan.
However, from a tax perspective there is a difference between the deductibility of the points you pay to get a home purchase loan vs a refinance mortgage. When you buy a house, you can fully deduct the points in the year in which you paid them. However, when you refinance, you must deduct the points over the life of the loan.
The only distinction from the financing aspect between a home purchase loan and a refinance loan is whether there is a change in ownership of the property during the financial transaction. When you get a home purchase loan, you are getting a loan to pay a seller so that the seller will transfer ownership of the house to you. In a refinance situation, you are the homeowner before and after the financial transaction. You are essentially replacing the existing mortgage with a new mortgage.
Why would you want to replace the existing mortgage with a new mortgage? There are basically three potential reasons:
Most people start thinking about the loan process after they make an offer on a property. This often leads to a tremendous amount of stress, haste, and a waste of time. Buyers are now stressed to qualify for the correct loan amount. They are hasty in taking the first loan offer they can get. They might have wasted their time in looking at homes that our out of their budgetary reach.
The first thing that all buyers should do before looking at properties is to figure out how much they could afford and to organize all supporting documentation into a loan package. This is called obtaining 'Pre-Approval.' Obtaining loan pre-approval from a lender is the single most important task one should accomplish before even looking at properties.
By knowing the size of the loan that a lender will give you and knowing whether the monthly payments and closing costs fit in your budget, you can more effectively define the scope of your property search. If you have a pre-approval from a lender, you also put yourself in a more competitive position when you make an offer on a property. For instance, when sellers receive multiple offers, seller s like to know that they are not wasting their time by accepting an offer from a buyer who ultimately will not get a loan. Because the purchase contract normally has a loan contingency tied in, a seller could in effect be taking the property off the market for a period of time, thus running the risk that other buyers who had made offers have now found other properties.
So, do yourself a tremendous service. Spend the time learning about home loan basics, the loan paperwork, and the loan process before you start searching for home in earnest. Get pre-approved! This advice is worth its weight in gold.
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