1) Why Refinance?
There are different reasons to refinance a mortgage loan, such as to obtain a lower interest rate, to shorten the term of the loan, or to consolidate debt.
It can be advantageous to refinance when you have a mortgage loan with a variable interest rate and are scheduled for a readjustment that will result in larger monthly payments, or when you have a loan on which you are paying only interest, and after a certain period of time you will start amortizing the principal, at which time your monthly payments will go up significantly.
A reduction in the interest rate means lower monthly payments, provided you keep the same term for the new loan. The savings in financing costs over the life of the loan, due to a lower interest rate, can be substantial.
The same concept applies for consolidating debt, that is, you can save money by requesting a new loan at a lower interest rate to pay off the balances of other mortgages with higher interest rates. Debt consolidation would be the case when, for example, you have an original mortgage to purchase the home, and later another mortgage to make an addition or improvement to the home.
When you refinance a loan in order to pay it off over a shorter term, the monthly payments will be higher, but you will end up paying off the loan in less time, you will save a considerable amount in interest, and you will accumulate more equity in your home in less time.
2) How Long Do You Plan to Stay in Your Home?
Refinancing basically consists of obtaining a new loan. With the proceeds from the new loan you pay off the balance of the existing loan. This carries a cost, and in order to determine whether or not it is advantageous to incur this cost in order to get a loan with more favorable conditions, it’s important to evaluate your own personal situation with respect to the home.
For example, if you plan to stay in the home for a long time, it may be advantageous to refinance. On the contrary, if you plan to move out of the home in a year or two, that may not be sufficient time to recover the refinancing costs through the savings you realize with the better conditions of the new loan. In such case, you can simply solve your problems by applying for instant direct deposit loan from websites like ElcLoans or CashNetUSA. But each case is different and all the circumstances need to be evaluated.
Basically, the refinancing costs, which are generally paid in cash but sometimes can be included in the amount financed with the new loan, should be compared to the savings you can obtain with the new loan.
For example, if the refinancing costs are $5,000 and your monthly payment, in the case of refinancing over the same term but at a lower interest rate, is reduced from $1.500 a month to $1.300 a month with the new loan, in one year you will have saved $2,400 in loan payments ($200 a month x 12 months), without taking into account the tax effect for the deduction of mortgage interest, the more rapid amortization of principal due to a lower interest rate, and the time value of money,
Therefore, you would not realize any real savings, in terms of cash flow, until the start of the third year of the new loan. The savings of $4,800 in the first two years would almost offset the refinancing costs of $5,000. In this example, it would probably not benefit you to refinance if you plan to stay in the home two years or less.
You could do the calculation in reverse. When you know the amount of the financing costs and the amount of your monthly payment with the new loan, you can divide the total refinancing costs by the total savings each month in the mortgage payment to determine the number of months it will take to recover the refinancing costs. In the above example, this would be $5,000 divided by $200 = 25 months. This is a simplified example and to calculate the overall effect, you would need to take into consideration the other factors mentioned above, such as the savings you can obtain in the total interest costs over the life of the loan.
3) Analyze All the Costs
The refinancing costs and the conditions of the new loan need to be carefully analyzed. When you are quoting with different financial institutions, it’s important to compare the overall cost of refinancing the loan. Refinancing expenses could be lower with one institution, but this could be offset by a higher interest rate on the new loan, or the situation could be the inverse, where you receive a lower interest rate with one institution, but with higher refinancing expenses.
The refinancing expenses could be higher when you are quoting with an institution other than the one with which you currently have your mortgage.
Charges for the loan application, credit review, title insurance policy, flood insurance certification and the fees of the bank’s attorneys can easily amount to over $2,000.
The points for originating the loan are on average 1.7% of the loan amount. Third-party charges can add another 1.1%, according to the U.S. Department of Housing and Urban Development.
You need to be aware of any prepayment penalty associated with your existing mortgage loan. This penalty could be from 1% to 3% of the loan amount when you refinance. The penalty could be gradually phased out, from 3% the first year to 2% the second year, and 1% in the third year.
All the charges incurred for a new loan should be compared to the savings that can be achieved with a new loan at a lower interest rate. In the website www.bankrate.com there is a refinancing calculator to help with this comparison. If it is not advantageous to refinance because of the prepayment penalty, you may need to wait a year or two, until the penalty expires.
4) Obtain All the Information You Need
Whether you are consulting with a loan officer in the financial institution where you presently have your mortgage regarding the possibility of refinancing, or you are quoting with other financial institutions, you should request a detailed breakdown of the refinancing costs and the conditions of the new loan.
If the loan officer does not already have this information, you will need to provide the amount you originally paid for the home, the amount you financed with the original mortgage, the balance you owe on the mortgage, and the amount of your monthly payments.
You should also ask the loan officer to calculate the amount you would pay each month with the new loan, and to clearly explain all the conditions.
Until all the details are finalized, such as the amount to be refinanced, the interest rate for which you quality, and the current market value of your home, the conditions quoted to you will be estimates. If you are getting quotes in different financial institutions, it is important that you get quotes based on the same data, so that they are comparable.
5) The Market Value of Your Home
With refinancing, there comes a new appraisal of your home, in order to determine its current market value. With the conditions that have existed in the real estate market, and especially in the market for private homes in recent times, you may find that the market value of your home has decreased significantly. You may even find that you owe more than the house is worth on the market.
You should inspect the appraisal carefully, to be sure it takes into account any renovations or other improvements you have made.
6) Availability of Credit and Interest Rates
Lenders, after the losses many of them have suffered as a result of foreclosures on subprime loans, may have established stricter standards for granting loans, and may have raised interest rates to try to cover their losses.
You should inquire about the interest rate for which you qualify based on your credit score. You can obtain a credit report that includes your credit score from the three credit reporting agencies for a small fee on the website www.myfico.com. You can use the tool on the home page called “The higher your FICO score, the lower your payments”, to see what rate of interest a person with your credit score would qualify for when applying for 3-month loans, and how much the monthly payments would be based on the amount you are requesting.
You should correct any errors on your credit report that may be adversely affecting your score. You should also do everything possible to reduce the balances you owe on credit cards, in order to help you in obtaining the most advantageous refinancing terms. Many lenders penalize debtors when the balance owed on their credit cards is more than 35% of their available credit.