Mortgages & Refinancing

Reasons for refinancing

To get a lower interest rate mortgage One of the main reasons homeowners refinance their mortgages is to take advantage of lower interest rates. For example, suppose you have a fixed-rate mortgage, but interest rates have declined since you first obtained your loan.  You may find that now you can get a new loan at a lower rate of interest. You can reduce your monthly payments when you refinance a higher rate loan for one with a lower rate. If you plan to remain in your home for several years, the savings you will realize in the form of a lower monthly mortgage payment could justify the costs of refinancing your home. Some lenders may offer a low- or no-cost refinancing (see page 13), in which case your recovery of upfront loan costs may be less of a concern.  How much lower should interest rates be before you consider refinancing? You may have heard a general rule of thumb that your new interest rate should be at least 1 percentage point lower than your current rate for the new loan to result in significant savings.  However, this is just a rule of thumb—you need to consider how long you plan to stay in your home and whether that amount of time will justify your upfront costs in refinancing your mortgage loan. If you’re only a few years away from paying off your current mortgage, it may not make sense to refinance.

You also may wonder when to lock in your interest rate. Usually, you can do so at loan application or approval, or you can float the interest rate until the loan closes. Ask your lender how long he or she will hold a quoted rate for you. You also should ask what happens if rates fluctuate before closing.  If rates have fallen, must you close at your locked-in rate or can you get the lower rate?  What if rates have risen?  Some homeowners think that each time the Federal Reserve lowers the federal funds rate, mortgage rates will decrease as well. This often isn’t the case, because most mortgage rates are not tied to the Federal Reserve’s well-publicized overnight borrowing rates. Fixed-rate mortgage interest rates typically track longer term rates set by the bond markets.  So when deciding when to refinance your home and lock in your new interest rate, be sure you look at the movement of interest rates for the type of mortgage you want, as opposed to just news headlines about Federal Reserve actions.

Build equity faster

Many homeowners want to build the equity in their homes more quickly and choose to refinance a longer term mortgage with a shorter term mortgage. Each month, a certain part of your payment goes to the interest expense on your loan, with the remainder being applied against the principal, or loan balance. With shorter term loans, a greater percentage of your monthly payment goes to the principal. For example, if you currently have a 30-year fixed-rate loan, you might consider refinancing for a 10- , 15- , or 20-year loan, which will lower the total amount of interest you will pay over the life of the loan and speed up the growth of equity in your home. However, remember that as you shorten the term of your loan, your monthly payment likely will increase.

To switch from an adjustable-rate loan to a fixed-rate loan

During those times when interest rates are higher,homeowners often choose adjustable-rate mortgages (ARMs), which traditionally have lower interest rates during their early years than fixed-rate loans. When rates drop, you may want to refinance for a fixed-rate loan, which provides the stability and predictability of knowing exactly what your mortgage payment will be for the life of the loan. Some ARMs have conversion periods that allow you to convert your loan to a fixed-rate mortgage for a one-time conversion fee. If you have an ARM now, be sure to ask your lender about this option.

To get a loan that recognizes your improved creditworthiness

If you had a history of credit problems when you took out your current mortgage, you may find that you can now refinance into a new mortgage that recognizes your improved credit by offering you a more competitive interest rate. People with a history of credit problems often have to pay higher mortgage interest rates. However, credit records change over time. So if your credit has improved since taking out your current mortgage, talk to a lender about refinancing into a loan that recognizes your current improved credit status. Before visiting a lender, you may want to call a credit bureau to get a copy of your credit report and make sure everything is reported correctly.  Ask lenders about Fannie Mae’s Timely Payment RewardsSM mortgage.  It’s a new mortgage designed for people with less than perfect credit that offers a competitive interest rate—plus up to a 1 percentage point drop in your interest rate when you make your mortgage payments on time over a two-year period. If you can qualify, it may prove to be a better deal than your current mortgage.

Draw on the equity already built up in your home

Often referred to as a “cash-out” refinance, you can tap a portion of the equity that has accumulated in your home and receive cash at your loan closing.  Equity is what your home is worth minus the amount you still owe on your mortgage. You can use this equity to pay for expenses such as your children’s education, or home improvements, or to consolidate other debt payments. For example, if your home is now valued at $150,000 and your loan balance is $80,000, you might be able to get a new $135,000 mortgage (cash-out refinances generally are limited to 90 percent of the total value of your home).  That would allow you to repay the existing $80,000 balance and use the $55,000 for other financial needs.

Is there any risk in a cash-out refinance?

Many homeowners like the flexibility that comes with a cash-out refinance. However, the more you tap into the equity in your home, the more your monthly mortgage payments may increase. In some cases, lenders may offer you a loan amount that is 95 percent, 100 percent, or even 110 percent of the value of your home. You may find that you’re being persuaded to use all the equity in your home to borrow money to pay off higher interest credit card bills, or to make home repairs, or even to take that round-the-world dream vacation.  Be sure you carefully evaluate all the terms of the refinance loans being offered to you, especially those that will exceed 90 percent of the value of your home. Such a refinance loan may have a higher monthly payment than your current loan and may carry additional upfront fees.  Be sure to ask the lender about any prepayment penalties, which could cost you thousands of dollars if you decide to pay off your mortgage early. If you decide to opt for a prepayment penalty, you should receive some benefit for doing so—such as a lower interest rate. Make sure you know of any large balloon payments that may come due at the end of a loan period. If not carefully evaluated and understood, these loan features could cost you more than you ever intended to pay.  When thinking about a cash-out refinance, it’s also important to know whether you’re really getting your debt under control or, in fact, taking on more debt. For example, interest rates on consumer loans and credit cards are usually higher than mortgage interest rates. It’s true that you may be able to pay off these higher interest debts by consolidating balances into a mortgage loan requiring monthly payments at a lower interest rate. However,by adding to your total mortgage debt, you’re borrowing additional money against the value of your home. Although debt consolidation through cash-out refinances may be appropriate in some circumstances, you should carefully assess the pros and cons of such a transaction, including tax consequences.  Although many homes increase in value over time, this doesn’t mean home values can’t or won’t decrease. If your property goes down in value, you may not be able to sell it at a profit and get the funds you need to pay back your refinanced loan amount. And if you lose your job and can’t find another, you need to know that you will have sufficient resources available to make the monthly mortgage payments. So don’t take on more of a monthly mortgage payment than you feel comfortable making. You don’t want to do anything that is going to increase the amount of your debt beyond what you are able to repay and risk losing your home.

Who is Eligible to Refinance?

To be eligible to refinance a mortgage, lenders usually require that you have at least 5 percent equity accumulated in your property. Equity is the difference between what your property is worth and the amount you still owe on the mortgage. For example, if your house is valued at

$100,000, and your mortgage balance is $90,000, you have $10,000 equity in your home. In this example, that equals 10 percent equity.

Refinance

Homeowners refinance their mortgage loans for many reasons, including to lower their interest rate and monthly payment, to build equity in their home faster by shortening their loan term, or to draw on the equity already built in their home through a “cash-out” refinance. You should carefully consider the following before making a final decision:

• your reasons for refinancing,

• the interest rate of the existing mortgage,

• the interest rate of the new mortgage,

• the cost of refinancing,

• how much equity you have built up in your home,

• how long you plan to remain in your home, and

• your current income and credit status.

Refinance - When Does It Make Sense?

With traditional refinancing, the generally accepted rule of thumb is that the interest rate for your new mortgage must be about 2 percentage points below the rate of your current mortgage for the refinance to make sense. However, with the newer low and no cost refinance programs, it can be worth your while to refinance to obtain a smaller reduction in interest rates.

How long you expect to stay in your home is also a factor to consider. If you'll be moving in a few years, the month to month savings may never add up to the costs that are involved in a refinancing.  There are numerous online refinance calculators online which help you make this decision.

Refinance

If you are planning to stay in your home for at least three to five years, it may make sense to pay "points" (a point equals 1% of the loan amount) and closing costs when you refinance to get the lowest available rate.

Refinance

When you refinance your mortgage, you usually pay off your original mortgage and sign a new loan. With a new loan, you again pay most of the same costs you paid to get your original mortgage. These can include settlement costs, discount points, and other fees. You also may be charged a penalty for paying off your original loan early, although some states prohibit this. The total expense for refinancing a mortgage depends on the interest rate, number of points, and other costs required to obtain a loan. To obtain the lowest rate offered, most mortgage companies will charge several points, and the total cost can run between three and six percent of the total amount you borrow. So, for example, on a $100,000 mortgage, the company might charge you between $3,000 and $6,000. However, some companies may offer zero points at a higher interest rate, which may significantly reduce your initial costs, although your payments may be somewhat higher.

Home Mortgage Refinance

Still paying a high interest rate on your mortgage? That extra money should be yours each month. When interest rates are 1% lower than what you are currently paying, it’s time to consider refinancing. This can mean great savings for you and your family. Refinancing your existing mortgage with a new, lower interest loan, changing the term of your loan, or even consolidating all your debts into this new loan will save you money, both monthly and over the life of the loan.

Look around and check refi rates, closing costs, etc. to make sure you squeeze the most out of your home mortgage refinance.

Time Magazine HELOC article

Time.com has a good article regarding HELOC:
With college-acceptance letters in the mail, hefty bills are sure to follow. If you're tempted to tap your home equity to help cover the tab, conditions are favorable. Real estate values are high, and interest rates low. Those not subject to the alternative minimum tax may also get a tax benefit. Here's a guide to the options. --By Ellen McGirt

 
HOME-EQUITY LINE OF CREDIT, (HELOC)

HELOCs let you tap the equity in your home as cash. You use checks or credit cards linked to the HELOC to draw on the money as needed. The average interest rate nationwide is 5.95%, but the debt on HELOCs is variable, meaning the rate you pay can go up over time. While the repayment period on HELOCs can vary from five to 20 years, these loans are better for those who expect to pay everything back within a few years, limiting the risk of rising rates. Note: because HELOCs are considered revolving credit, if you max out your line, it will affect your credit score.

HOME-EQUITY LOAN

These loans give you a lump sum of cash at a fixed rate (current average: 7%), with low or no closing costs and a typical term of five to 15 years to repay. That simplicity and predictability is valuable. There are hidden costs, however. If you borrow enough to cover four years of tuition, you'll need to reinvest whatever you don't use right away. And even so, you may not offset the interest you're paying for money you don't need yet.

CASH-OUT REFINANCE

If you take out a new mortgage for more than the outstanding balance of the old one, the difference is returned to you as cash. Because the financing vehicle is a mortgage, you have a wide range of options: 30-year fixed (current average: 6%), 15-year fixed (5.6%) or adjustable (5.4% for a five-year adjustable). This is the perfect option if your existing mortgage carries above-market rates and you're not close to paying the loan off. Extending the life of a mortgage can add thousands in extra interest over the years. Also, refinancing generally adds about $2,000 in closing costs, and you'll still have to worry about reinvesting any unused proceeds.

Tax Advantages from Home Equity & Refi

Refi points
While points-deductibility is a tax-saving option buyers should explore any time they get a loan to buy another home, a taxpayer who simply refinances also might be eligible for this tax break.

In most refinancing cases, a homeowner must deduct any loan points over the life of the loan. But if part of the refinanced mortgage proceeds are used to improve the main home and tests 1 through 6 listed above are met, the portion of points attributable to the improvement money can be deducted in the year paid. The same rules apply to home equity loans or home equity lines of credit.

If, however, you use the extra refi or home equity cash for something else, such as paying college costs or buying a car, you still can deduct the points but not completely on one tax return. The points deductions must be parceled out over the equity loan's term.

To figure the annual deduction amount, divide the total points paid by the number of payments to be made over the life of the loan. You should be able to get this information form your lender.

Advantages to equity line and refinancing for remodeling

The Daily News Transcript has an article on advantages of Home Equity Line of Credit for remodeling:

There are generally three main reasons why people might want to refinance. 1) They want to take advantage of lower mortgage interest rates; 2) They want to tap some of the equity in their home; 3) They want to exchange one type of loan for another - typically an adjustable rate for a fixed rate. People may refinance for one or all of three reasons. It is also possible to increase the size of your outstanding mortgage by refinancing it, assuming that you have sufficient equity in your property to support the larger loan.

A home equity loan is a second mortgage with a lot more flexibility than a mortgage. With a traditional second mortgages you receive a separate loan for a specified amount that must be repaid within a specified time frame through monthly payments, just like your first mortgage.

However, with an equity loan you would make payments only as you tap the credit. The loan is really a line of credit that you can access (or not access) as you need to. Usually, you only have to support the interest on the credit you access. You do not have to (but can) pay on principal until some years out. You can continue borrowing against your equity line and making the required payments at any time over the life of the loan.

In deciding whether to refinance or obtain an equity line of credit, you should consider the repayment schedule and interest rate structure. Home equity loans typically are adjustable and are pegged to a fairly volatile interest rate (often the prime rate). If you refinance, you will have the choice of a fixed or an adjustable rate loan. Equity lines tend to be relatively short term, usually no more than 10 years. As a result, the monthly payments on an equity line would be higher than on a refinance of the same amount which could be written for as long as 30 years.

As a general rule if you are looking for a relatively small amount of equity or if you want to establish a reserve fund to have available if you need it over a fairly short time period, an equity line is the best choice. But if you need a larger sum for a specific purpose with a longer payback schedule, refinancing may be better.