Refinance Guide
The most common reason for refinancing is to save money. Saving money through refinancing can be achieved in two ways:
1. By obtaining a lower interest rate that causes one's monthly mortgage payment to be reduced.
2. By reducing the term of the loan, thus saving money over the life of the loan. For example, refinancing from a 30-year loan to a 15-year loan might result in higher monthly payments, but the total interest paid during the life of the loan can be reduced significantly.
People also refinance to convert their adjustable loan to a fixed loan. The main reason for doing this is to obtain the stability and the security of a fixed loan. Fixed loans are very popular when interest rates are low, whereas adjustable loans tend to be more popular when rates are higher. When rates are low, homeowners refinance to lock in low rates. When rates are high, homeowners prefer adjustable loans to obtain lower payments.
A third reason why homeowners refinance is to consolidate debts and replace high-rate loans with a low-rate mortgage. The loans being consolidated may include second mortgages, credit lines, student loans, credit cards, etc. In many cases, debt consolidation results in tax savings, since consumer loans are not tax deductible, while a mortgage loan is usually tax deductible.
The answer to the question, "Should I refinance?" is a complex one, since every situation is different and no two homeowners are in the exact same situation. The conventional wisdom of refinancing only when you can save 2 percent on your rate is problematic. If you are refinancing to lower your monthly payments, the following calculation is more appropriate compared to the 2 percent rule:
1. Calculate the total cost of the refinance--example: $2,000
2. Calculate the monthly savings--example: $100/month
3. Divide the result in 1 by the result in 2--in this case 2000/100 = 20 months. This shows the break-even time period. If you plan to live in the home for longer than this period of time, it likely makes sense to refinance.
Sometimes, you do not have a choice--you are forced to refinance. This happens when you have a loan with a balloon payment and no conversion option. In this case it is best to refinance a few months before the balloon payment is due.
Whatever you're considering, consulting with a seasoned mortgage professional can often save you time and money. Make a few phone calls, check out a few web sites, crunch on a few calculators and spend some time to understand your options.
Most Common Refinancing Mistakes
1. Refinancing with your existing lender without shopping around. Your existing lender may not have the best rates and programs. There is a general misconception that it is easier to work with your current lender. In most cases, your current lender will require the same documentation as other companies. This is because most loans are sold on the secondary market and have to be approved independently. Even if you have made all your mortgage payments on time, your existing lender will still have to verify assets, liabilities, employment, etc. all over again.
2. Not doing a break-even analysis. Determine the total cost of the transaction, then calculate how much you will save every month. Divide the total cost by the monthly savings to find the number of months you will have to stay in the property to break even. E.g., if your transaction costs $2000 and you save $50/month, you break even in 2000/50 = 40 months. In this case you'd refinance if you planned to stay in your home for at least 40 months.
Note: This is a simplified break-even analysis. If you are considering switching from an adjustable to a fixed loan, or from a 30-year loan to a 15-year loan, the analysis becomes more complex.
3. Not getting a written Good Faith Estimate of closing costs.
4. Paying for an appraisal when you think your home value may be too low. Have the appraisal company provide a list of comparable sales (typically at no charge) to provide you with a range of possible values. Your mortgage company's appraiser or your Realtor may do this for you. Do not waste your money on a full appraisal if you are doubtful about the value of your home.
5. Using the county tax-assessor's value as the market value of your home. Mortgage companies do not use the county tax-assessor's value to determine whether they will make the loan. They use a market-value appraisal which may be very different from the assessed value.
6. Signing your loan documents without reviewing them.
7. Not providing documents to your mortgage company in a timely manner. When your mortgage company asks you for additional documents, provide them immediately. They are doing what's necessary to get your loan approved and closed. Delays in providing documents can be costly.
8. Not getting a rate lock in writing. When a mortgage company tells you they have locked your rate, get a written statement which includes the interest rate, the length of the rate lock and details about the program.
9. Pulling cash out of your credit line before you refinance your first mortgage. Many lenders have cash-out seasoning requirements. This means that if you pull cash out of your credit line for anything other than home improvements, they will consider the refinance to be a cash-out transaction. This usually results in stricter requirements and in some cases can break the deal!
10. Getting a second mortgage before you refinance your first mortgage. Many mortgage companies look at the combined loan amounts (i.e., the first loan plus the second) when refinancing the first mortgage. If you plan on refinancing your first loan, check with your mortgage company to find out if getting a second will cause your refinance transaction to be turned down. There are many programs where you can apply for both a first and second at the same time. |
