Why Consider Refinancing Your Mortgage?

Refinance Topics

Refinance Calculator

Introduction

"Fees" and "No Fees"

Switch from an Adjustable Rate Mortgage (ARM) to a Fixed Rate Mortgage

Switch from a Fixed Rate Loan to and Adjustable Rate Mortgage (ARM)

Take Cash Out of your home

Eliminate Mortgage Insurance (MI)

Refinancing is simply taking out a new mortgage.  If you are considering refinancing your home loan, the first steps are determining your short and long term goals and then evaluating the different types of refinance programs available.   Once you have your goals to what's available, you will be able to make an informed decision on how you want to proceed.

The first thing to consider is your current interest rate.  If you purchased your home when interest rates were high or if you have an adjustable rate mortgage, chances are refinancing to a different- lower term may be able to save you money immediately and over the course of your loan.  If you purchased or refinanced your home when interest rates were low, refinancing may not be the best thing to do. In the past, it was a general rule that refinancing makes good financial sense if your current interest rate is at least 2 percentage points higher than the current market rate and you plan on owning your home for at least 3 years.  The 2 point difference in the interest rate was necessary in order to recoup refinance fees. Nowadays, it makes sense to consider refinancing with less fluctuation in the interest rate because it is possible to refinance and pay no fees or no points! You consider the length of time for which you will own your home because of the costs involved in refinancing. 

Is your current interest rate 2 percentage points above the current market rate?

Do you plan to stay in your home for at least 3 years?

Any loan where the lender pays all of your closing costs (title & escrow fees, appraisal, lender's fees, etc.- any non-recurring expenses), is commonly referred to as a ``no-cost'' loan. A true ``no-closing cost'' loan differs from both a ``no lender fee'' loan or a loan in which the lender adds the closing costs to the amount financed. A ``no lender fee'' loan, sometimes advertised by banks, usually will not cover the title, escrow, and other outside charges you may need to complete the refinance.

With a true ``no-closing cost'' loan, you can refinance for any incremental drop in your interest rate since the transaction costs are zero. Even in a declining rate market, where you believe rates may continue to fall, a no-cost loan will make sense. Should rates continue to decrease you will have invested nothing in the loan costs, and can simply refinance at any time. Some borrowers refinance every year or less!

There are a variety of interest rate and point combinations available to the borrower at any point in time for the same product or loan type. As an example, for a loan amount of $200,000 a borrower can be quoted 6.75% with .875% points, 7.0% with zero points, or 7.25% with no closing costs. All three of these quotes are for a 30 year fixed rate mortgage. The lender allows the borrower to choose amongst rate and point combinations since some people prefer a lower rate immediately, while others prefer minimizing how much they pay out of pocket up front. Thus, the borrower can select the combination which feels most comfortable to their personal situation. For some borrowers, the no closing cost option of 7.25%, while providing a slightly higher rate, still requires the least investment up front and therefore is the best option.

No cost loans will always carry a slightly higher rate than a loan that does not pay your costs. In general, a no cost loan is the better strategy if you plan to keep your loan for the next two and a half to three years. Longer than that, you should consider paying the costs yourself to get a lower rate. Over time, the lower rate will save you more money. And if you plan to keep the loan for four to five years, it often makes sense to pay points to get an even lower rate.

When your loan includes fees, there are several fees associated with refinancing a loan The fees described below are the charges that you are most likely to encounter in a refinancing.

Application Fee. This charge imposed by your lender covers the initial costs of processing your loan request and checking your credit report.

Title Search and Title Insurance. This charge will cover the cost of examining the public record to confirm ownership of the real estate. It also covers the cost of a policy, usually issued by a title insurance company, that insures the policy holder in a specific amount for any loss caused by discrepancies in the title to the property. Be sure to ask the company carrying the present policy if it can re-issue your policy at a re-issue rate. You could save up to 70 percent of what it would cost you for a new policy.

Lender's Attorney's Review Fees. The lender will usually charge you for fees paid to the lawyer or company that conducts the closing for the lender. Settlements are conducted by lending institutions, title insurance companies, escrow companies, real estate brokers, and attorneys for the buyer and seller. In most situations, the person conducting the settlement is providing a service to the lender. You may also be required to pay for other legal services relating to your loan which are provided to the lender. You may want to retain your own attorney to represent you at all stages of the transaction including settlement.

Loan Origination Fees and Points. The origination fee is charged for the lenders work in evaluating and preparing your mortgage loan. Points are prepaid finance charges imposed by the lender at closing to increase the lender's yield beyond the stated interest rate on the mortgage note. One point equals one percent of the loan amount. For example, one point on a $75,000 loan would be $750. In some cases, the points you pay can be financed by adding them to the loan amount. The total number of points a lender charges will depend on market conditions and the interest rate to be charged.

Appraisal Fee. This fee pays for an appraisal which is a supportable and defensible estimate or opinion of the value of the property.

Prepayment Penalty. A prepayment penalty on your present mortgage could be the greatest deterrent to refinancing. The practice of charging money for an early pay-off of the existing mortgage loan varies by state, type of lender, and type of loan. Prepayment penalties are forbidden on various loans including loans from federally chartered credit unions, FHA and VA loans, and some other home-purchase loans. The mortgage documents for your existing loan will state if there is a penalty for prepayment. In some loans, you may be charged interest for the full month in which you prepay your loan.

Miscellaneous. Depending on the type of loan you have and other factors, another major expense you might face is the fee for a VA loan guarantee, FHA mortgage insurance, or private mortgage insurance. There are a few other closing costs in addition to these.

A homeowner should plan on paying an average of 3 to 6 percent of the outstanding principal in refinancing costs, plus any prepayment penalties and the costs of paying off any second mortgages that may exist.  Because costs may vary significantly from area to area and from lender to lender, the following are estimates only. Your actual closing costs may be higher or lower than the ranges indicated below.

If your adjustable (ARM) has moved up on you in the last few years and you don't feel like starting with another low rate only to watch it move again,  consider refinancing into the security of a fixed rate loan. You must remember that all fixed rate loans are not the same.

Today's market offers numerous choices for loans that are fixed for a shorter time than the traditional 30 or 15 years. Loans are available with fixed rates for 3, 5, 7, and 10 years and the shorter the initial fixed period, the lower the interest rate. All of these loans are amortized over 30 years so there's no need to worry about the payment being too high. All you need to do is match up how long you expect to keep the loan with the closest fixed term. This may be shorter than how long you plan on keeping your home, if you feel comfortable with the refinance process.

Types of Loans

At the end of the fixed term, these loans automatically convert into ARMs with adjustments annually, so there is no balloon payment.  Often the current fixed rates will be above the rate on your current ARM, unless of course, you are several years into your adjustable. You will need to decide if the security and insurance against further rate increases is worth the additional payment that you might incur.

Switching to an adjustable (ARM) really can make sense in some situations. If you've recently decided to start looking for a new home, or will be relocating within the next few years, it may make sense to evaluate your current loan. By switching from a 30 year fixed to a low rate adjustable or short term fixed, such as a 3 Year Fixed, you can save substantially over the remaining time that you'll be in your home. In this type of situation it almost never makes sense to pay closing costs, so shop for a no cost loan with a slightly higher rate. Also, don't take a loan with a prepayment penalty, unless the prepayment is waived upon sale of the home. This strategy can be best explained by showing an example. For simplicity, we're assuming that your loan balance is the same on both the refinance and original loan.

The primary advantage of home mortgage loans is that the interest costs are deductible for tax purposes. If you are currently paying a higher rate of interest on credit cards, car loans, or other forms of debt that are not deductible, it may make sense to pull the cash out of your home (provided that you have the equity) and use it to pay off those other debts.

Lenders will typically allow you to borrow up to 75% of the appraised value of your home in a cash out refinance. (Some lenders will go up to 80%, however the loans offered will be less competitive than at 75%.) Paying off other bills or credit cards, buying a new car, sending the kids to college, investing in an Internet start-up, or buying additional real estate are all good reasons to refinance your home and take cash out.

Even if you're able to keep you credit card interest rate at 8-9% with low introductory offers, when you consider the tax savings of your mortgage interest, you will be paying less interest if those balances were part of your mortgage instead. If you are paying 8% on your mortgage and your tax bracket is 33%, your net interest rate is 5.3% which is still less expensive than any credit card program over time.

If you purchased your home with less than 20% down, chances are you have a loan that is insured by ``Mortgage Insurance'' (MI). Most borrowers are aware that they are paying MI on a monthly basis, but you can check your mortgage statement if you're not sure. As your home appreciates or your loan balance decreases (or a combination of the two), your equity in the home will exceed 20%. At that time a favored method of eliminating the MI tied to the loan is to refinance. The savings of eliminating the MI alone will often warrant refinancing.

Be aware that mortgage lenders value your property at what comparable homes have sold for in the last 6 months, not the price at which they are currently listed. If you are close to that 20% mark, ask your mortgage source to provide you with a ``comp search'' estimate (this service should be available for free) which will give you an idea of how your lender will view your home's value.