Home Refinance Guide
Chances are your needs have changed since you initially took out your existing loan, which is why many people today find themselves looking at refinancing options. Did you know that you could refinance whether interest rates are rising or falling, and you are not limited to working with just your current lender?
Let's start by looking at some of the different types of refinancing available today:
Rate And Term RefinanceWith a rate and term refinance, the only terms of your new agreement that differ from your old one are the interest rate, the term, or both.
For example, you could choose to change your existing 30-year mortgage at 5 percent to a 30-year mortgage at 4 percent (a rate refinance). Then there's a term refinance, which would see your 30-year mortgage at X percent changed into a 20-year deal at the same rate (a term refinance).
It's even possible to get a reduced rate and a reduced term in the same arrangement.
Most people who refinance select this option.
Cash-out RefinanceWith a cash-out refinance, you borrow more money than your outstanding balance and receive the excess as cash.
Let's say you originally borrowed $200,000 to buy your house. You've made diligent payments over the last few years, and your outstanding balance is now $175,000. In the meantime, though, your house's value has increased, and it's now worth $275,000. You could secure a new mortgage based on your home's new value; pay off your outstanding balance, and keep the excess money for yourself.
Cash-in RefinanceIn contrast to a cash-out refinance, the cash-in version sees you using a chunk of money you've managed to save or acquire to pay off part of your old mortgage, which can result in a shorter term, a lower rate, or both. The main reason why someone would choose a cash-in refinance is to cancel mortgage insurance premium (MIP) repayments, which are no longer applicable with lower loan-to-value (LTV) ratios. A cash-in refinance may allow you to gain access to lower rates, which are often only available with lower LTV ratios.
The BenefitsMaybe you didn't get the mortgage process quite right the first time around. Refinancing gives you a second chance to renegotiate your terms and (potentially) save yourself from a long-term deal that isn't favorable for you.
Secure a lower interest rate. If you're a cash-strapped homeowner, obtaining a lower interest rate can save you a small fortune every month, and potentially be the difference between remaining in your home or facing foreclosure. For example, by reducing the interest rate on a $250,000 loan from 6% to 4%, you can save as much as $300 per month.
Convert an adjustable rate mortgage to a fixed one. Adjustable rate mortgages typically offer homeowners lower rates at the beginning than fixed-rate mortgages, which is why they are popular with first-time buyers looking to get their feet on the first rung of the property ladder. After this initial low period, though, adjustable mortgage rates often change, which can lead to higher payments for homeowners. Low rates coupled with predictable payments make fixed-rate loans a more attractive proposition for many homeowners.
Cash out your equity. Cash-out refinancing allows you to release some of your equity in as cash. You can then spend that cash on anything you want – home improvements, debt reduction, starting a business, etc.
The PitfallsRefinancing is not a universal solution, and it has its pitfalls. You'll want to consider your personal situation before committing to a new deal.
More closing costs. When you bought your home originally, you paid closing costs to complete the purchase. When you refinance your home, you have to pay closing costs again, including, for example, an application fee, title insurance and title search, lender's attorney review fees, and an origination fee. These closing costs can easily run to several thousand dollars, so it's important to know if you will recoup them through your refinancing arrangement, especially if you're not going to stay in your house for long.
A potential prepayment penalty. Some lenders will charge you a prepayment penalty for paying your loan off early. These fees vary widely according to the specific terms, but can easily equal several months of mortgage payments.
There's no guarantee you'll get accepted. If your credit situation or income has changed over the years, you may find that your refinancing plans are halted in their tracks. Lenders will scrutinize your credit report and financial information before making a decision. Lenders will also appraise your home's value before considering a refinancing agreement. This appraisal is usually based on the sale prices of similar properties in the local area. If the appraiser concludes that your home is worth less than what's owed on it, your refinancing plans will be stymied.
Final ThoughtsRefinancing your home can make a lot of financial sense, particularly if it reduces your payments, shortens the term of your loan, or reduces your interest rate. When used carefully, it can also help you get your wider debts under control. For example, a cash-out refinance could help you pay off credit card balances and other loans and consolidate your debt. However, trading unsecured debt for a mortgage secured against your house could lead to bigger problems further down the line. If you fail to keep up with your repayments, you could lose your home – a reality that wouldn't necessarily be the case had you just kept your credit card balances.
You need to remember that refinancing has associated costs. It could take you years to recoup these costs, so if you are not planning to stay in your home for a few more years, the numbers might simply not make financial sense.
The bottom line is you need to run the figures and see if refinancing makes financial sense for you. Fortunately, there are plenty of online home refinance calculators to make this process easier.