Refinancing & Other IssuesWhen Should I Refinance?Reasons To Refinance
There are three main reasons that may motivate you to refinance your existing mortgage:
- Interest rates have dropped below the rate that you currently have on your mortgage loan.
- You may refinance to raise capital, or simply put, by borrowing additional money from the equity in your home during the refinancing process.
- Another compelling reason to refinance results from a balloon mortgage coming due, can force the borrower to obtain another loan.
Declining Interest Rates
Anyone who has ever obtained a mortgage loan will probably agree that one of the most nerve-wracking experiences in their life was watching mortgage interest rates ebb and flow as they gambled on when to lock-in a rate on their loan.
Interest rates have historically been very volatile. The mortgage industry has become quite competitive. As a result, homeowners can take advantage of the competition and bargain down rates and costs.
Raising Capital
You may be able to borrow money as part of the refinancing process, provided you have enough equity in your home -- much like a home-equity loan. This can make good financial sense, because under most circumstances, mortgage interest is tax deductible. The best part is you may be able to keep your monthly mortgage payment the same as before you refinanced, even though you have borrowed some cash.
Here’s an example:
Current 30-Year Mortgage New 15-Year Mortgage New 30-Year Mortgage
| Term |
30-year |
15-year |
30-year |
| Original Loan |
$95,500 |
| Principal to Refinance (outstanding balance) |
$92,800 |
$92,800 |
$92,800 |
| Interest Rate |
10.125% |
7.25% |
7.75% |
| Points |
|
0 |
0 |
| Monthly Payment |
$846.92 |
$847.14 |
$664.83 |
| Years Remaining |
26 years |
15 years |
30 years |
| Payments Remaining |
$264,239 |
$152,485 |
$239,339 |
| Amount Saved Over Life of Loan |
|
$111,754 |
$24,900 | * Provided you have enough equity available -- see the section on "Appraisals".
As you can see from the above example, when you refinance your current mortgage at a lower interest rate, you can borrow an additional $12,000 and still keep the same monthly payment. Can you think of reasons you may want to raise capital through refinancing? Here are a few good reasons:
- Financing improvements to your home.
- Consolidating debts; paying off higher-rate consumer debt, such as credit cards, or an auto loan.
- Starting a business.
If one of your reasons was to pay for a vacation, you are not on the right track. Remember that you could be jeopardizing the security of your home by frivolously increasing mortgage debt.
Refinancing to raise capital makes sense if you want to keep your loans consolidated and have one monthly payment. It also gives you the benefit of being able to spread the payment out over a longer number of years if you need to.
CAUTION!: Although a longer payment period keeps your monthly payment lower, it increases the total cost of the mortgage.
Be careful not to overextend yourself and be sure to plan for emergencies. In the section titled "Tapping the Equity in Your Home", you’ll find a detailed discussion of tapping the equity in your home. The section also contains examples that can help you determine if you can take out additional money when you refinance.
Getting Into A Different Type Of Loan
Sometimes, saving money or raising more money is not always the objective in a refinance. You might be forced to get a new loan. Balloon loans, which come due and payable in full at a predetermined time, may require you to get a new loan. When a balloon loan comes due, you will do the same type of investigation that you would if you were getting a brand new loan.
Adjustable (ARM) To Fixed-Rate
Refinancing to go from an ARM to a fixed-rate mortgage can be comforting. The peace of mind knowing that your mortgage payment won’t fluctuate with changes in interest rates may allow you to sleep easier. A fixed-rate mortgage is most beneficial for those who plan on staying in their homes for a number of years. Of course, it may not make financial sense to do this if the cost of the fixed-rate loan is higher. We will cover this in more detail later on.
Adjustable To Another Adjustable
It may be very tempting to want to switch into another ARM when lenders offer very low introductory rates, called teaser rates. With a teaser rate, your first year interest rate and monthly payments would be significantly lower; but, if you plan on staying in your home for more than one year, the second and subsequent year rates will probably be the same or (more likely) higher than the rate you would have had on your original ARM. So be cautious when considering this!
Fixed-Rate To Adjustable
If you plan on selling your home within the time period that the ARM adjusts (one year, two years, etc.), it may be good for you to go from a fixed-rate mortgage to an ARM. For instance, say you are looking at a 5-year ARM. The mortgage rate on that loan will not change until the end of the fifth year. If you are pretty sure that you will sell your home within the 5 years, you may save money by doing this.
30-Year To 15-Year Loan
There are advantages and disadvantages to moving from a 30-year loan to a 15-year loan. Let’s take a look at some.
Advantages to 15-Year Loan Disadvantages to 15-Year Loan
| Interest rate is usually lower. |
Your monthly payment is higher -- make sure you can afford it. |
| Allows you to pay down your mortgage faster and build equity in your home. |
Depending on the economy and how long you plan to stay in your home, building equity may not be your best investment. |
| Provides a forced discipline of putting more money each month toward paying down debt. |
Reduces financial flexibility... with the higher monthly payment, there is less money around each month. This could be a problem if a financial emergency comes up. |
Refinancing: 15-Year Mortgage Versus 30-Year Mortgage.
The example below compares the potential savings that will result by refinancing a 30-year mortgage to a 15-year mortgage with a lower interest rate or to another 30-year mortgage with a lower interest rate.
Current 30-Year Mortgage New 15-Year Mortgage New 30-Year Mortgage
| Term |
30-year |
15-year |
30-year |
| Original Loan |
$95,500 |
| Principal to Refinance (outstanding balance) |
$92,800 |
$92,800 |
$92,800 |
| Interest Rate |
10.125% |
7.25% |
7.75% |
| Points |
|
0 |
0 |
| Monthly Payment |
$846.92 |
$847.14 |
$664.83 |
| Years Remaining |
26 years |
15 years |
30 years |
| Payments Remaining |
$264,239 |
$152,485 |
$239,339 |
| Amount Saved Over Life of Loan |
|
$111,754 |
$24,900 |
What does this example show us? Going from a 30-year loan to a 15-year loan kept the monthly payment about the same and significantly reduced the total amount required to pay off the loan. This works great if your goal is to pay down debt faster.
Keeping the loan at a 30-year payment period significantly decreases the monthly payment from $847 to $664 and saves you money over the life of the loan. This works great if you are looking to reduce your expenses or you are looking to have more money to invest.
Of course, you must also consider how long you intend to remain in the house. If it will only be a short period of time, an analysis of the cost of refinancing (there is a cost to it) compared to the projected savings will need to be addressed.
HOT TIP! If you can’t afford the payment on a new 15-year mortgage, consider a 20-year term. 20-year loans are offered by many lenders.
When Does It Make Financial Sense To Refinance?
To determine if you should refinance you’ll need to:
- Gather information from potential lenders regarding interest rates, fees and loan types, and
- Evaluate the information to determine if the refinance makes financial sense for you.
By the term financial sense, we mean, ‘will it wind up saving you money in the long run?’ There are costs associated with refinancing a mortgage (see the section titled "Costs of Refinancing".) A refinance only makes sense when you will stay in your home long enough to recover the costs of refinancing. This period is called the break-even point. So, if you’ll only be in your home for a few years, it may not make sense to refinance. Take a look at the break-even point worksheet in this chapter. You’ll also need to evaluate whether or not it makes sense to pay points. See the section titled "The Point of Points".
Article Content by Truebridge, Inc. All rights reserved. Copyright 2001-2010 |
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