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.
Some common reasons homeowners refinance include:
monthly mortgage payments
- Convert an
adjustable rate mortgage (ARM) to a fixed-rate mortgage
- 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 points below your existing mortgage rate.
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 balance.
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.
may plan to movie 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.
For example, 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.
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. Check
with your tax professional.
Talk to your
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.