Mortgage refinance is big business. Refinancing a home loan can be a disaster or win-win for both homeowner and lender. To know when is home mortgage refinancing the best decision, you must be informed about the current credit climate, your personal goals and financial needs.
What Is Home Refinancing?
Just to be clear, let’s define what is home refinancing. It is not adding money to your existing mortgage or taking out another loan. Refinancing means getting a new mortgage to replace the original loan. The first home loan is paid off, allowing the second loan to be created and replace the first.
[GARD align=”left”]Most borrowers go through the time and effort of a mortgage refinance to get a better interest rate or loan term. There are many other reasons.
Most people are able to refinance only when they have equity in their property (value of the property is greater than the balance on the mortgage). Risk-averse lenders want to make sure there is equity to protect their position if they have to repossess.
What Is Your Goal For Mortgage Refinance?
Before even considering the refinancing options available, you must understand what is your goal for mortgage refinance. What do you want to accomplish? Some goals for home refinancing include:
- Reduce mortgage interest rate
- Reduce total interest paid over the life of the loan
- Reduce monthly mortgage payment
- Restructure the loan (e.g. from an ARM to a fixed-rate mortgage)
- Finance a balloon payment or extend the term of the loan
- Consolidate debts
- Capital for home improvements
- Pay for college tuition or repay student loans
- Obtain funds to start a business
- Obtain funds to buy a vacation home for cash
1. Reduce Interest Expense
Refinancing to reduce interest expense is the most common goal for both business and home refinancing. This can be crucial if you started with an adjustable rate mortgage (ARM) at a very low interest rate that jumps several points after a few years. Occasionally homeowners want to refinance in to the lower initial rates of an ARM when they plan to move in a few years.
2. Debt Consolidation
A debt consolidation mortgage loan offers benefits when the borrower is paying off more than one home mortgage or auto loan.
Paying off credit debt with a home mortgage refinance is questionable. Although the interest rates are high, credit debt is unsecured. Consider carefully whether you want to risk your home to secure this type of debt. Even at the lower rate, you could pay thousands more in interest expense by taking 30 years to pay off the balance transferred from credit cards to your mortgage.
3. Reduce Monthly Mortgage Payment
Extending the term of the loan to reduce monthly mortgage payment is another common goal for home mortgage refinancing. In times of personal financial strain or crisis, this may be the only available option to avoid repossession and keep payments within your income.
Cost Of Mortgage Refinance
Home mortgage refinancing just to get a lower lower interest rate isn’t always the best decision. The finance industry uses the slang term “refinancing junkies” for people who always migrate to the latest, greatest lower mortgage interest rate.
The closing costs add up. For a detailed breakdown of the cost of mortgage refinance fees, read the article Home Refinance – Consider The Costs
Measure the savings relative to the refinance closing costs. For instance, if your closing costs are $3,675 and your new terms provide a monthly payment reduction of $105, it will take 35 months (almost three years) of those monthly savings just to recoup the home refinance closing costs.
Feel free to play around with the Mortgage Loan Calculator tool in the right hand column to see how much interest you will pay for closing costs. Using our example of $3,675.00 at an interest rate of 3.95%, over a 20 year term you would pay $1,646.54 in interest for the closing costs alone!
Refinancing your home loan multiple times reduces the overall benefit of lower interest rates. Closing costs are usually added to the principal so that you pay interest on them over the term of the loan. Ideally, you only want to refinance once on your current mortgage.
Should I Refinance My Mortgage?
By asking, “should I refinance my mortgage?” you realize it’s a big decision that can affect your finances for decades. Analyze your personal goals. Do some number crunching. Get it all down on paper. Sleep on it. Do a gut-check. Then crunch some more numbers if you need to.
Here are some other considerations that may help you decide whether refinancing a mortgage is right for you at this time.
1. How Long Will You Own The Home?
For refinancing to make sense, you have to own the house for several years. If you plan to move or sell your home in the next few years, you should probably stay in your current mortgage.
2. You’ve Had Your Mortgage For Many Years
During the early years, a greater portion of your monthly payment goes to pay interest. As your principal balance slowly decreases over the years, you reach a middle point when more of the payment starts applying to principal. Now you are building more equity.
Use the Mortgage Loan Calculator tool to see how much interest versus principal will apply in future payments on your loan. By refinancing late in your mortgage amortization, more of your monthly payment will be credited to paying interest again and not to building equity.
Only you can decide whether meeting your goal is worth losing equity by refinancing your mortgage. Just make sure it’s an informed decision.
3. Prepayment Penalty
A prepayment penalty is a fee that lenders might charge if you pay off your mortgage loan early. Check to see if your existing mortgage loan documents includes this clause (and avoid it in future loans). Like closing costs, paying a mortgage prepayment penalty increases the time to break even.
Tip: If you are refinancing with the same lender, ask whether the prepayment penalty can be waived.
4. Your Credit Number
How is your credit history? If your credit number is high, you might qualify for competitive closing cost packages and a lower interest rate. If your mortgage refinance goes through the same lender, a good credit history may allow reduced fees.
With poor credit history, your negotiating power is limited. Is your home mortgage refinance goal to consolidate debt or lower payments to avoid repossession or bankruptcy? Then it may be a small price to pay to gain control of your finances. You’ll have to crunch the numbers and search your soul.
More information on mortgage loan basic concepts and legal regulation can be found at http://en.wikipedia.org/wiki/Mortgage.