your home can be an excellent way to bring down your
monthly mortgage payment, raise cash, or consolidate
debts with high interest rates. However, you need
to do your homework before deciding to refinance.
One important factor is the difference between current
interest rates and the rate of your original loan.
You also need to take into account the amount of time
it will take to recoup the costs of refinancing.
should you refinance?
Some common reasons homeowners refinance include:
- Lower monthly
an adjustable rate mortgage (ARM) to a fixed-rate
- Raise funds
for family expenses (i.e. college tuition)
- Pay off
The old rule
of thumb is that you should refinance your home if
interest rates fall more than 2 percent. That's because
refinancing usually involves most of the same closing
costs (loan origination fee, prepaid interest, etc.)
as the original loan. For anything less than 2 percent,
the savings on your monthly mortgage payment might
not be significant enough to be worth your while.
For some homeowners, though, the 2 percent rule is
not as important as the time needed to break even
on the refinancing. For instance, if it costs $3,000
to refinance a house, and the monthly mortgage payment
is lowered by $90, it would take almost 3 years for
the savings to cover the costs of refinancing.
If all the
information (survey, title search, etc.) for your
old loan is still current, however, the lender may
be willing to waive many of the fees. In addition,
you may be able to roll the closing costs of a refinance
loan into the new note. In other words, you don't
avoid the closing costs, but instead pay them back
over time along with the rest of the loan. If you
consider this option, be sure to calculate the potential
savings vs. the expense of paying off a higher principal
Keep in mind
that refinancing usually lengthens the time it takes
to pay off your house. If you are 3 years into a 30-year
mortgage and then refinance with a new 30-year loan,
you'll end up making payments on the house for 33
years. Nevertheless, if the monthly savings are substantial
enough, you still could end up paying much less over
the long haul with the new loan.
Rate Mortgages (ARMs)
Timing can also be a factor in switching from an ARM
to a fixed-rate loan. For example, rising interest
rates might influence you to covert your ARM into
a fixed-rate loan if you plan to stay in your house
for several more years.
you may plan to move in a year or two, and find a
lender who is willing to offer you dramatic interest
rate savings with an ARM. In this case (and as long
as the closing costs are minimal), it might make sense
to switch from a fixed-rate loan to an ARM.
Refinancing with a new loan doesn't mean you have
to give up all the money you've paid towards your
old mortgage. With each payment, you build up a certain
amount of equity in a property--which is the amount
you've paid on the principal balance of the loan.
if you have a $100,000 loan at 8 percent, you would
build about $2,800 worth of equity in the first 3
years. Thus, if you refinanced, the new loan would
only amount to $97,200.
cash with home equity loans... use caution
If you've built enough equity, you can refinance in
order to take cash out of the property. Perhaps you
need money to pay off your credit cards, add a new
bathroom, or cover the costs of braces for a child.
Regardless, lenders will typically allow you to borrow
against the equity you've built in your house, plus
appreciation (often up to 75 percent of the current
appraised value). These types of loans are also called
home equity loans.
however, of lenders offering 100 percent or 125 percent
home equity loans--their rates are often markedly
higher than traditional lenders. In addition, any
amount you borrow that is above the market value of
the house is NOT tax deductible.
to your lender
With all the different types of refinancing loans
available today, you should take some time to shop
around and speak with several lenders before making
a decision. Be sure to discuss all the expenses and
benefits, as well as what will be expected of you,
in advance. The more you educate yourself, the better
your chances of finding the right refinancing package.