Mortgage rates have been so low for so long that it is hard to believe nearly everybody hasn't refinanced to a lower rate. Take a moment to determine if it's right for you.
There are numerous reasons why you may want to refinance your mortgage: getting a lower interest rate, shorten the term of your mortgage, switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage (or vice versa), or tap into equity built up in your home.
However, refinancing may cost 3% to 6% of the loan's principal, and may incur additional fees for an appraisal, title search, as well as application fees. It is essential for homeowners to assess whether his or her reason for refinancing provides the actual advantages they are seeking from it.
Securing a Lower Interest Rate
In recent years, there exists an excellent opportunity to refinance to minimize the interest rate on your existing loan. Traditionally, the rule of thumb was that it was cost effective to refinance if you could lower your interest rate by at least 2%. Presently, many lenders claim 1% savings is sufficient of an incentive to refinance. Minimizing your interest rate not only helps you save money, but it boosts the rate at which you build equity in your home, and it can also lessen the size of your monthly payment. Current interest rate for a 30 year fixed rate loan can perhaps be in the low 3% range, and potentially even lower for a 15 year fixed rate loan.
Shortening the Loan's Term
At the time interest rates fall, homeowners frequently have the opportunity to refinance an existing loan for another loan that, lacking much change in the monthly payment, has a shorter term.
For example, refinancing a 30 year fixed rate mortgage on a $100,000 home, from 9% to 5.5% cuts the term in half to 15 years, with only a trivial change in the monthly payment from $801.33 to $814.15.
Not only have you locked in the rate of the loan, but also the duration, keeping your payment basically the same. That may be the better option, rather than simply reducing the rate alone and paying a lower payment monthly; especially as you near retirement.
Switching the Type of Loan
Both Fixed and Variable (Adjustable Rate Mortgage- "ARM") loans have their advantages and disadvantages. On the most basic level having a fixed rate loan is great because you know exactly what your payment will be each month for the life of the loan. The Variable loan will likely have a lower introductory interest rate when you first open the loan, but based on where rates are today they are most likely going to go up within the next 30 years.
While this sounds less than ideal, it may be a chance you're willing to take if you know you will not be in the home you own for an extended period of time, thus affording you a lower monthly payment for the time being. If you have an ARM loan and plan to stay awhile, you may want to lock in a fixed rate. If you have a higher fixed rate and don't plan to be in your current home much longer, you may consider switching to an ARM loan. However, due to historically low fixed rates, most homeowners aren't taking the risk of an ARM at this time.
Tapping Equity and Consolidating Debt
Mortgage refinancing can be a greasy slope to never-ending debt. It is recommended to remember, when including refinancing with the intention of tapping into home equity or consolidating debt.
Usually, certain homeowners justify this refinancing by pointing out that home improvements add value to the home, or the interest rate on the mortgage loan is less compared to the rate on money borrowed from another source. Lastly, the interest on mortgage could be tax deductible on your tax return.
On the other hand, few homeowners refinance so as to consolidate their debt. At a face value, substituting high-interest debt with a low-interest mortgage is an excellent idea. Sadly, refinancing does not yield an automatic dose of financial forethought. When you use this option you also need to ensure you alter previous habits or events that may have lead to the accumulation of your high-interest debt. This change in previous behavior will ensure you do not find yourself in the same situation again, with an even larger total debt balance.
HARP Government Refinance Program
There is also a government refinance program called Home Affordable Refinance Program (HARP), for those still owning more on their loans than their home is currently worth. To qualify, borrowers bust have loans backed by Fannie Mae, Freddie Mac or the FHA. This program has no underwater limits, no appraisal fees, no underwriting fees, modified fees, and less paperwork. There is no minimum credit score needed for this program either. HARP has been extended several times, but is slated to expire on December 3 1, 20 16. Be sure to check with your tax preparer prior to pursuing.
The Bottom Line
Refinancing can be a good financial shift if it lessens your mortgage payment, shortens the term of your loan or helps you build equity more quickly. When used with great concern, it can also be a valuable weapon in getting your debt under control. Prior to your refinance, take a careful look at your financial situation and question yourself.
- How long do I plan to continue living in the house?
- What do I expect my income stream to look like over the duration of the new loan?
- How much money will I save by refinancing?
- What are upfront costs and expenses when I refinance?
- Will the lender pull a soft inquiry to spare my credit score?
- What is my long term objective?
- How much paper work is required?
Remember to review the loan contract carefully. Ensure the terms are stated exactly how you were anticipating. Also, check to make sure the final titling is correct or the same as before. Often we see that the home is not transferred to the name of the living trust as intended, but the deed is recorded as joint property outside the living trust. This is a terrible mistake when all you wanted was to save money but it costs you and your family more grief in the end.
These and other questions are good to review with, and have answered by, your CPA or financial advisor before you talk to your lender. This is a good year to get your "financial house" in order.