There is a lot of talk these days about the merits of refinancing a home loan. But is it all hype, or is there something to it?
You may understand the basics, but still have questions about the intricacies of taking on a new obligation, and in some cases extending the payment timeline, for your home. Here are meaningful ways to sort out the claims and decide if the financial savings justify the expenditure of time, energy and any upfront cash. Sometimes the dollar difference in refinancing may be substantial enough over the long term to justify the effort.
Remember to consult with a financial professional to see what fits your unique situation best.
Why Refinance Your Home?
The often quoted "rule" is that you should be able to reduce your interest rate by at least three-quarters of a percentage point before you should consider refinancing your home.
Obviously, almost no one would willingly refinance in order to pay a higher interest rate. But refinancing to obtain a fixed rate long-term mortgage rather than an adjustable interest rate may, in some cases, be a wise decision, especially if large rate increases are expected. There are also cases in which a homeowner might want to convert a private loan into a standard mortgage, consolidate a "first mortgage" with a home improvement loan, or refinance a mortgage in advance of an approaching balloon payment.
At the outset, you'll want to know the amount you might save, and you can plug figures into a mortgage loan calculator to get a general idea.
In addition to the interest rate, there are other considerations:
- The length of time a homeowner expects to remain in the home
- The actual dollar amount, and other possible uses for the monthly or annual savings
- The total dollar amount to refinance, and the type of new loan, and
- The homes equity, if any
- If the equity in the property is 20% or more, or if you can pay additional cash to establish that equity position, you might be able to eliminate the need for private mortgage insurance. That alone can result in substantial savings.
- There are also cases where a homeowner may be able to qualify for a higher loan amount at a lower interest rate while still keeping the total house payment the same. In this case, the extra cash might be used for other purposes like education, investments, or adding to a retirement nest egg
- Refinancing may also let you keep your monthly payments at the same level, but reduce your loan term. By opting for a 15 or 10-year mortgage, you can potentially pay off a home sooner and also save a substantial sum in the amount of total interest you pay over the life of the loan
The Path to Refinancing
Your mortgage is a huge commitment! It's important to understand how refinancing will change your interest rate, and whether or not that change is the right move for you.
Qualifying for a new home loan will usually require similar documentation that you provided for the original mortgage. Interest rates are partially determined by your credit score. Before you make a new application, take a serious look at your total financial picture; if you have high credit card balances, substantial secured debt, or minimal savings, you might not be in a favorable qualifying position to refinance your home.
Weigh your options carefully. It is helpful to examine, in concrete terms, just how much you might save through refinancing. While lowering your mortgage interest rate might seem like a good idea, there are other ways to improve your financial health. It pays to view your mortgage as only one part of your broader financial picture.
Refinancing, in some cases,requires cash up-front. Average costs to refinance run between three and six percent of the loan amount, according to lending professionals. Run the numbers to determine how long it will take to recoup that initial expenditure. Then, calculate your savings based on the time you expect to live in the house to get a quick idea about whether it's a sensible move.
Look at what other uses there might be for that money: Investment account, educational fund, vacation, contingency fund for home repairs or improvements, or an emergency fund. Remember that some financial planners recommend that home owners have six to twelve months of expenses in reserve before even considering refinancing.
Many homeowners decide to review how a lower interest payment might affect their allowable income tax deductions and the effect on federal and state taxes. Take a look at both short-term advantages and long-term consequences of any new loan you consider.
Steps to Take to Refinance a Home
Buying a home, particularly a first home, is equal parts emotional decision and financial reality. People want a good deal, but they also want a home they can see themselves living in. Refinancing, on the other hand, is primarily an economic decision. Once you analyze your reasons and come to a decision on a "proved by the numbers" basis, you should turn your energy toward finding the best refinancing deal. Talk to a reputable mortgage broker or a trusted financial adviser to learn what types of new mortgages are available, what the qualifying requirements are, and the interest rate you can expect based on your preliminary financial information.
Undertake some preliminary legwork on your own. Know, within reasonable parameters, the current value of your home. In many cases, a REALTOR might be able to assist in the current value of your home. They can prepare a CMA (Comparative Market Analysis) to give you an idea of your current homes worth - though a CMA is not considered an appraisal.
Additionally, get a copy your most recent credit report and review it in advance. Be ready to collect and supply necessary documentation in order to satisfy the mortgage underwriters. Whether your goal is to lower your payments, protect your investment, reallocate your resources or shift the burden of payment to some time in the future, the loan itself must be advantageous for both you and the lender.
Lastly, ask a mortgage broker or banker to supply you with an estimate of all charges, including points, that constitute your "all-in" costs to refinance. Be sure you understand and have cash available for the various fees involved. Realize that many so-called "no cost" refinance programs often simply hide some fees in higher interest rates and ongoing loan charges. Evaluate the overall costs of different loans to see if it will be better to pay the fees in advance.
The Home Ownership and Equity Protection Act (HOEPA) was enacted to protect borrowers against unfair practices. If you have any misgivings, you can find specific information about allowable rates, charges and procedures by consulting a compliance guide issued by the Consumer Financial Protection Bureau. Although it does not address all types of loans, it does offer valuable information if you're considering refinancing.
Any decision involving home financing should be approached carefully and with an objective mind. Do not be afraid to ask questions to financial professionals - educating yourself will help you make an informed decision based on the positives and negatives of refinancing.