A lower mortgage interest rate can save you a lot of money over the life of your loan, but it may not be the only reason to refinance. Maybe your income and credit score are higher than when you first purchased and now you qualify for a better rate? Maybe you've built up enough equity and it's time to get rid of your private mortgage insurance? Or maybe you want to review your options for taking cash out of your home for debt consolidation or a home improvement project?
Every homeowner has different needs and goals, which can vary over time. Speaking with an expert to examine your options from a variety of angles is always advisable.
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- If you have an adjustable rate mortgage, you may want to refinance into a fixed-rate loan in order to get payment stability and lock in your low rate so it can’t increase with the market.
- If you need cash to renovate your home, finance a business or pay college costs, you can refinance to access the equity in your home without having to sell it.
- If you are at risk for rising monthly costs or foreclosure due to a resetting home equity line of credit or home equity loan, refinancing can save your home and lots of money.
Breaking barriers: ‘no-cost’ refinancing
One of the main barriers to refinancing can be the up-front closing costs. However, you may be able to avoid some and maybe all of the out-of-pocket financing costs many borrowers pay.
For instance, instead of paying $3,000 in closing costs you might agree to accept a loan with a slightly larger mortgage amount or rate to cover all of those up-front closing costs.
Loans where lenders pay closing costs are sometimes called ‘no cost’ refinances, but there usually is a cost – it’s simply delayed. Instead of paying upfront, you’re paying over time. However – and this is the key point – with a ‘no cost’ refinance you can get a new loan if rates are low or when other benefits even if you don't have the cash for closing at the moment.
Future plans count in whether to refinance
If you’re going to spend on closing costs on a refinance, you want to be sure the loan will continue for enough time to get your money back. Suppose you can refinance today and cut your monthly mortgage payment by $140? If refinancing costs $3,000 that means you generally must stay in the property at least 22 months to recover that investment. If you are planning to sell your home next year, you need to factor that in.
Less paperwork can cut down on the hassle
Getting a mortgage often involves a lot of paperwork. The good news is that refinancing can be far less complex than a purchase. For instance, with FHA Streamline Refinances and the VA’s Interest Rate Reduction Refinance Loans (IRRRLs), you can often get replacement financing without income verification or an appraisal. Such options mean that for many borrowers, refinancing is possible today with fewer documents to unearth and fewer worries about property values or a recent income slide.
In the example of the loan with $3,000 in closing costs, we said it was "generally" worth considering if you could save $140 a month and expected to stay in the property for at least 22 months. However, you want to assure that you continue to get the benefits of amortization, the gradual paying down of the loan balance. If you refinance a loan after five years instead of getting a new 30-year mortgage, consider getting one with a 25-year term so you don't extend your potential repayment period and face higher potential interest costs over the long term as a result.
Refinancing to combine a home equity line of credit that has reset is another major consideration for when to refinance. With home equity lines of credit, there's usually a ‘draw’ phase and a ‘repayment’ period. Let's say the draw phase lasted 10 years and at the end of that time the borrower owes $63,000. After the draw period, there is period to repay the outstanding debt. At 5 percent over a five-year repayment period, the monthly cost for principal and interest is $1,189 – enough to sink many household budgets and maybe even lead to foreclosure. If the full amount of a home equity loan was borrowed, the borrower still owes that money as a second mortgage. Refinancing your first mortgage to combine your home equity loan or credit line one payment can create lower monthly payments, save money and avoid a skyrocketing payment.
Republished April 12, 2018
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