What Is Refinancing?
In a way, "refinancing" is a misleading term, because it suggests to many homeowners, a process of changing or altering their mortgage. In fact, refinancing is simply the process of taking out a new mortgage, and using the money obtained to close out - or pay off - your current mortgage.
That means refinancing involves many of the same steps that were involved in applying for and getting your mortgage in the first place - and can also involve some of the same expenses.
On the other hand, depending on how the terms of mortgages that are available now compare with the terms of your current mortgage, refinancing can save you a significant amount of money.
Balancing Act
Refinancing is most likely to make sense for you if your current mortgage has an interest rate that is higher than current rates.
If you refinance with a lower interest rte, you'll pay less each month - even if your new mortgage is for the same amount as your current mortgage. (Of course, the process of getting a mortgage involves costs of its own). Traditionally, the decision on whether or not to refinance has meant balancing the savings of a lower monthly payment against the costs of refinancing
But in recent years, lenders have introduced "no-cost" and "low-cost" refinancing packages that minimize or completely eliminate the out-of-pocket expenses of refinancing. (These refinancing packages compensate with a higher interest rate, or by including some of the costs in the amount that is financed).
With the newer low- and no-cost refinancing programs, it can be worth your while to refinance to obtain a smaller reduction in interest rates.
When refinancing makes sense.
1. Save money on interest rates.
If you got your mortgage when interst rates were higher than they are now, refinancing could make sense for you. Refinancing at a lower rate will reduce your monthly payments, and if you plan to stay in your home for a reasonably long time, these lower payments will more than make up for the costs associated with refinancing. You can also benefit by consolidateing higher rate credit card and auto debt into the new home loan.
How much lower should interst rates be? That depends on how much the refinancing will cost you. With the newer low-cost and no-cost refinancing options, refinancing can make financial sense with small differences in interest rates.
2. Convert an adjustable-rate mortgage (ARM) to a fixed-rate mortgage.
You may have chosen an ARM for its lower initial interest rate. But if prevailing interest rates are currently low, you may decide to opt for the predictable monthly payments of a fixed-rate mortgage.
Converting your ARM to a conventional fixed-rate mortgage can make sense if rates are low.
3. Convert an adjustable-rate mortgage (ARM) to an ARM with more desirable features or lower rates.
Most ARMs have protective features, called caps, that limit the amount the interest rate or monthly payments can increase. You may want to look for an ARM that offers you better protections than your current loan - which can not only make you feel more financially secure but deliver significant savings.
And even though the interest rates on ARMs fluctuate with prevailing market rates, you may hae one that's tagged to higher indices - and carries a higher interest rate - than other ARMs currently available.
4. Build up your equity faster.
If your financial resources have improved since you obtained your mortgage, you may decide to convert to a mortgage with a shorter term - perhaps a 15-year mortgage instead of a 30-year mortgage. The monthly payments will be higher, but your overall interest costs will be substantially lower, and if current interest rates are below those of your existing mortgage, your monthly payments may not increase by very much at all.
This can be very advantageous as you near retirement. A shorter loan term may enable you to own your home before you retire.
5. Convert some of your equity to cash.
If you've held your mortgage for some time, you will have begun to reduce substantially the outstanding principal on your loan. That means you'll be able to finance a considerably larger amount than you owe on your current mortgage. You can use the difference - which can be tens of thousands of dollars - for major purchases, to finance college costs, or pay off higher rate credit card debt.
Costs... And No-Costs.... Of Refinancing
How must will refinancing cost you? So much depends on your specific situation that it's impossible to give a simple answer.
With traditional refinancing, you should expect to pay an average of 3 percent to 6 percent of the oustanding principal in refinancing costs. That is, if you've paid down your original $80,000 mortgage so the outstanding principal is now just $60,000, you can expect refinancing costs to run between $1,800 and $3,600. Add to that any prepayment penalties you may face for paying off your mortgage early, and the costs of paying off any second mortgages you have.
Today, however, many lenders offer no-cost and low-cost refinancing. These no-cost and low-cost loans compensate for the lack of up-front expenses either through a somewhat higher interest rate, or by including the costs of refinancing in the amount of the loan. At Madison-Mortgages, we can show you what your options are and which one is right for you.
The costs of traditional refinancing
- Title search and title insurance. The title search confirms your legal ownership of the house, and ensures there are no outstanding claims against the property. Title insurance guards the lender against a mistake in this searh, and is almost always required. Be sure to ask the company carrying the present title insurance policy if it can re-issue your policy at a re-issue rate. A re-issue could save you up to 70 percent compared to a new policy. Your current lender can tell you who is carrying your title insurance policy.
- Appraisal fee. This fee covers the costs of an independent appraisal of the value of your home for your lender's use in evaluating your application.
- Loan origination fee. This fee covers remaining costs associated with processing your mortgage application and completing your loan.
- Discount points. Discount points are essentially prepaid finance charges, paid when you close on your mortgage loan, usually to obtain a mortgage with a lower stated interest rate. Usually, a lender will offer a number of mortgages with different combinations of interest rates and discount points; the higher the interest rate, the fewer the discount points charged at closing.
* One point is 1 percent of the value of the mortgage (for example, $800 on an $80,000 mortgage).
- Closing agent and review fees. Usually the lender will charge you fees for the services of the closing agent, who actually conducts the closing. You may also be charged for other legal services involved in completing your loan.
- Prepayment penalties. Some mortgages carry a penalty for paying off the loan before the stated term is up. While this practice varies by state, type of lender and type of loan (for example, for FHA, VA and some other types of loans, prepayment penalties are forbidden by law), prepayment penalties can be quite substantial.
The mortgage documents for your existing loan will tell you if you face a prepayment penalty, and, if so, how large it is.
- Other costs. Depending on your mortgage, you could face fees for a VA loan guarantee, FHA or private mortgage insuarnce, and a variety of other possible closing costs.
