Refinancing a Mortgage Loan
- Types of Refinancing
- Rate and Term Refinancing
- Cash-Out Refinancing
- Cost of Refinancing
- Mortgage Break Even Level
- Advantages of Refinancing
- Reducing Your Monthly Payments
- Paying Off Your Loan Faster
- Getting Cash Out of your Home
- Consolidating your Debt
- Remove Private Mortgage Insurance
- How to Refinance
There is nothing more frustrating than making a purchase after weeks of research only to find out the price of the product you purchase has dropped. If you’re a bargain hunter, you might be kicking yourself for not waiting a few days or weeks to see if the items went on sale. It would be great to have a do-over when this occurred, and in the mortgage market, a refinance of your mortgage allows this to be accomplished.
A mortgage refinance is the process of changing a mortgage you already have on an existing home. This could be a first home, or a vacation home, or even an office building. When you undertake a refinance, you are entering into an agreement to purchase a new mortgage, which is simultaneously paying off the old mortgage. Before you decide to refinance your home, there are several things you should keep in mind including, the timing of your refinance, the risks of refinancing, as well as, the costs associated with a refinance of your mortgage.
Types of Refinancing
Rate and Term Refinancing
When you refinance a mortgage, you might be looking to accomplish several goals. You might be trying to reduce your monthly payments by reducing the interest rate on your original mortgage, or you might be thinking about borrowing more capital, especially if the value of your home has increased relative to the time when you initially purchased it.
Rate and term refinancing financing focuses on the monthly payments by evaluating the old interest rate relative to current interest rates as well as the term of your loan. Obviously, you will benefit from a lower rate, but this new rate needs to account for the costs you will incur by going through the refinancing process.
For example, if you can refinance your loan and lower the interest rate from 5% to 4%, on a $100,000, 15-year fixed mortgage, you will save approximately $1,000 per year. This amount would pay for your refining costs but might take 2-3 years. If you were only able to reduce your interest rate from 5% to 4.875%, you would only save $125 per year, which probably would not cover your new closing costs.
What you need to know
Rate and term financing, allows you to change the interest rate as well as the term of your loan. You might be able to reduce your payments by extending the loan from 15-years to 30-years, which would allow you to pay a lower monthly payment over a longer period. By using the combination of both interest rates and term, you can find the payments that meet your current financial goals.
Cash-out refinancing is a way for you to change the rates that you are paying, alter the term, as well as, increase the loan amount relative to your initial mortgage. Your loan amount when you are cashing out is increasing and you are receiving cash by extracting the equity in the value of your home.
For example, if the value of your home increased from $300,000 to $600,000, and you want to take advantage of the increase in the value of your home, but don’t want to sell your home, you can refinance your home, and receive cash. A cash-out refinance is like a home equity loan, in that you are extracting the value of the equity.
What you need to know
Lenders have a formula that they use to determine if they should offer you cash-out refinancing. Most lenders will use the same criteria they used to determine if you can pay back the loan if on your new mortgage. The cash out value is generally 80% of the appraised value of your home. The appraised value is based on many criteria including recent comparisons to sales in your neighborhood.
For example, if the new value of your home is $600,000, then a lender will provide you a loan based on 80% of that value or $480,000. If you initially borrowed 80% of a $300,000 loan, or $240,000, then you would be able to double the mortgage and use the additional $240,000 for anything you want.
Cost of Refinancing
While the fees of refinancing are not as extensive as your initial mortgage there are several fees, which you will need to consider prior to starting the process. When you are considering a refinance, you don’t have to go back to your original lender, and you should shop around to find the best deal possible. Origination fees are generally the largest chunk of your refinancing fees, and you should try to negotiate with your lender. Origination fees can be as large as 1.5% of your loan, so spend some time discussing how to reduce this figure. You can actually negotiate this fee with a lender. Most of the other fees will be fixed, such as the appraisal fee, your tax fee, the title insurance fee, along with an inspection fee, your recording fees, and your survey fees.
Remember, even though you own the home, the new lender needs to perform their due diligence before taking on a new loan. Additionally, just because your lender wrote your mortgage loan, it does not mean they still own the loan and are just replacing a new loan for an old loan. Here is a list of fees that you should expect:
- Appraisal fee
- Credit Report
- Home Inspection
- Owner’s Policy Title Insurance
- Origination Fee
- Pest Inspection
- Private Mortgage Insurance (PMI)
- Property Tax
- Recording Fees
- Survey Fee
- Underwriting Fee
Mortgage Break Even Level
Most of the time, your goal will be to pay less over time. If this is the primary goal, you should look to calculate a breakeven point, where the upfront costs of your refinance will be made up by a reduction in payments to your lender over time. Fees can vary per lender, but you should expect the origination fee to make up the bulk of your loan. The breakeven point is how many months it takes to break even where the savings you are receiving from your new loan incorporates the upfront payments you need to make to refinance your home.
Here is an example of how to figure out your breakeven level:
In the example, you initially have a mortgage with payments of $1,199 per month. You can calculate your savings by subtracting your new monthly payment which is $1,073 which generates a savings of $126 per month. You can calculate your after-tax savings by multiplying your tax rate by the savings rate. Obviously, this will differ depending on your tax rate. You can then tabulate the sum of your closing cost for your new loan, and then divide the total after-tax savings rate per month by the total cost to refinance your loan to derive the number of months that it will take to recover the refinancing costs of your loan.
Advantages of Refinancing
In addition to reducing the overall cost of your loan, a refinance can be an attractive way to help you handle budget concerns, help you increase your cash position, eliminate PMI payments, and pay off your loan at a quicker rate. If you determine that the costs of refinancing are worth it, here are ways that you can also benefit.
Reducing Your Monthly Payments
A lower rate and the same term (for example a 15-year mortgage), will lower your monthly payments. But you can also lower your monthly payments by altering the terms of your mortgage. For example, if you change your 15-year loan to a 30-year loan, your monthly payments will decline. In fact, if your goal is to lower your monthly payments you might not care if the rate you use to refinance is lower than your initial loan rate.
Paying Off Your Loan Faster
If your goal is to pay off your loan faster, then changing the terms of your loan will allow you to do this. For example, if you change your 30-year fixed loan to a 15-year fixed loan, you will pay back your loan at a quicker rate. You might find that interest rates have declined sufficiently to make these payments attractive, but most of the time, if your goal is to reduce the term, your monthly payments will increase.
Getting Cash Out of your Home
Many people want to take advantage of an increase in the equity value of their home. What this means is that the value of your home has increased since it was purchased. Instead of selling your home, you can refinance it and take advantage of the equity in your home. When you do this, you are taking out a larger loan than your original mortgage, that is based on the new value of your home. Your payments will likely increase, to incorporate a larger mortgage.
Consolidating your Debt
If you have outstanding debt, you can use the extra cash you receive from a large refinance to pay this off. Many times, the interest rate you pay on your mortgage is lower than the interest rate you have on other forms of debt, which makes this an attractive proposition. For example, if you are paying 12% credit card debt, but your mortgage rate is 4%, then it makes sense to consolidate your debt with a mortgage refinance.
Remove Private Mortgage Insurance
If you had to pay private mortgage insurance on your initial mortgage, then paying off your initial loan with a refinance can wipe out these payments. If the equity in your home increased, and you own more than 20% of the value of your home, then refinancing will create this added benefit.
How to Refinance
You would start the refinance process by determining your goals, whether it’s strict to reduce your payments or to lower your overall payments or even to get cash out of your home. Next, you should shop online or call a broker to determine if this process if possible. There are dozens of free refinancing calculators such as the one you can find on FX Empire.
You should also spend time searching for the best loans with the most attractive conditions. Many times, banks will offer special closing costs to homeowners who are looking to refinance. The best time to look to refinance is when rates are low and moving lower. When interest rates begin to rise, the cost of refinancing will begin to become more expensive. Search loan aggregators, such as FX Empire to find the most attractive rates.
You should make sure your credit score reflects your current credit history. Make sure there are no issues prior to applying for a refinancing loan.
Look for mortgage rates and the terms on loans that will allow you to meet your financial goals. Once you have found a lender and have shopped around, you will apply for a new loan. You will need to supply your tax returns, as well as income information, and the lender will do a credit search. If you qualify, your mortgage refinance will be sent to an underwriter who will survey your home with an inspection and a title search.
Refinancing your mortgage can be very beneficial and save you a substantial amount of money monthly as well as allow you to take advantage of the increase in the equity of your home. You can start the process on your own or call a lender to determine if a refinance is right for you.
Before you close on your new loan, you should have a clear goal of what you want to achieve from the refinancing process. For example, is your goal to save money on the new loan, or to reduce your monthly payments, or to cash out and benefit from the rise in the equity value of your home. You might decide that you want to pay off your loan as quickly as possible or get rid of your monthly PMI payments. A refinance can accomplish many of these goals, and you should have a clear understanding of the costs of your refinance and when you will break even.
You need to do your own due diligence, and you can use websites such as FX Empire to help you find the loans with the lowest rate, as well as, calculate your new monthly payments and determine how this will alter your current monthly budget.