Refinance for Savings
If you're dazzled by new low interest
rates and dream of reducing your monthly mortgage payments, if you foresee a
major expense, or if you simply want to pay down credit card debts with a
better interest rate, you might just get what you wish for. In matters of real
estate, there's rarely a quick and easy formula for all, but the profiles below
will help you pinpoint your refinancing options.
Some of the primary reasons for
refinancing are to lower monthly payments, pay off a loan or build equity
faster, convert an adjustable rate mortgage (ARM) into a fixed-rate mortgage,
or change other loan terms.
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If you can refinance today with a
"no-cost" loan at a lower interest rate—meaning you pay no points or
closing costs, and the interest rate is actually lower than your current
rate—run, don't walk, to your lender's office. But this golden scenario rarely
applies. As a next step, ask yourself these three questions, and see why
they're so important.
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1. |
How long do you plan to stay in
your house? The most important question you can ask when
considering refinancing is: Will you be in your home long enough to reap the
benefits despite its costs? If you plan to be in your home three years or
less, you probably have little or nothing to gain by refinancing except a passel
of paperwork. However, if you know you'll be in your current house five years
or more, refinancing could make for substantial savings. ·
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2. |
What will a refinance cost you in
points, transaction fees, and other closing costs? Ask your lender for an amortization chart
showing the real expense of pre-paying interest points and for a modified
Annual Percentage Rate (APR) spreadsheet combining these costs over the years
you estimate keeping your home. If you're considering a no-points loan, weigh
carefully the additional interest and other fees that may be hidden in higher
mortgage rates. |
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3. |
How long have you held your
current mortgage? If you're on the "back end" of a
fixed-rate loan—meaning you've already taken advantage of most of your
tax-deductible interest—taking out a new loan could be beneficial, since you
can deduct the interest and prorated points year by year. |
Potential Disadvantages of Refinancing
1. Unlike
a first mortgage, tax deductions for points are amortized over the life of the
loan, not all together in the year you pay them. (If you sell your house or
refinance again in the future, the remainder of the interest you prepaid in
points will be deductible in that year.)
2. If
your existing loan agreement includes a prepayment penalty clause, it could
negate the benefits of refinancing, since by refinancing you're paying off your
current loan to open a new one.
3. The
term of your loan could begin anew from your refinance date. Talk to your
lender about negotiating your loan term.
Finally, even if
refinancing isn't a good choice today, your lender may be willing to make
changes to your current loan to adapt to your needs.
Home Equity for Cash
For homeowners who need
a lump sum of money or a revolving credit line to pay for a specific cost such
as college tuition, medical expenses, or reducing non-deductible credit card
debt, home equity options make more sense than refinancing. Owners who have
built up equity through a first-mortgage down payment, paying down some
principal, or an increase in property values can borrow against that equity.
Home equity options are
usually based on a given percentage of your home's appraised value, minus your
remaining mortgage balance. For example, if your home is appraised at $150,000,
then 80 percent of that total would be $120,000. If your remaining unpaid
mortgage is $80,000, the result would be $40,000 of available equity. (Note:
Many banks now offer lines of credit at 90 or even 100 percent of your home's
loan-to-value ratio.) As with a mortgage loan, the actual loan amount may vary
depending on your credit history, outstanding debts, income, and the like.
Interest rates are
variable, usually one to three points above prime—and because your house stands
as collateral, interest is also tax-deductible. That's the good news. The
downside is that because your house is used as security, you could lose it if
you fall behind on payments. Home equity options include:
Home Equity
Loan
These are traditional
fixed-rate loans that work well if you need a lump sum of cash—say, to start a
business, pay college tuition or medical expenses, or consolidate credit card
debt. Home equity loans are similar to second mortgages in that payments are
usually made monthly over 10 to 30 years, resulting in full repayment by the
end of the loan.
If you choose a
variable-rate equity loan, your lender must give you an example of minimum
monthly payments and maximum interest for the particular amount you would
borrow. Fees often apply, including points, application fees, appraisal, and
credit check. However, if you pay more points up front to borrow at a 100
percent loan-to-value (LTV) ratio, all or some of these charges may be waived.
The annual percentage
rate (APR) for a home equity loan takes points, fees, and interest rate into
account. Be sure to ask your lender for a chart of the loan's APR, and discuss
whether an equity second mortgage makes more sense than refinancing with a new
first mortgage.
Home Equity
Line Of Credit
Home equity lines of
credit are more flexible and usually carry a shorter term than home equity
loans. This is a good option for homeowners who have occasional or irregular
needs for extra cash, such as car payments or even protecting against overdraft
fees on a checking account. With an equity credit line, you receive a specific
credit limit based on a percentage of your home's appraised value (usually 75%)
minus your remaining mortgage balance. Your ability to repay is also taken into
account. One advantage of this option is that you pay interest only on the
amount you use, so you don't run up interest charges for unused portions, and
using nothing costs you nothing.
Agreements are often
divided into a draw period and a payback period. During the draw period,
commonly five to ten years, you can withdraw any portion of the funds at any
time by writing checks against the credit line. Payments revolve back into your
credit line as available funds. In some cases you might make payments on
interest only until the loan comes due. When the draw period ends, you may be
allowed to renew the line of credit, or your full outstanding balance might be
due in one payment. Minimum withdrawal amounts or monthly payments may apply,
as well as other limitations, all of which will be spelled out in your
agreement.
The APR for equity
credit lines is calculated differently than for equity loans—points and other
fees aren't rolled into the APR, only the periodic interest rate is—so be
careful when making cost comparisons. Because a variety of credit-line plans
are available with different terms, costs, and APRs, discuss the options with
your lender.
Potential Disadvantages
Of Borrowing On Equity:
1. Your
home is at stake if you're unable to make payments.
2. Using
equity options too freely reduces your actual equity.
3. If
you sell your home before repayment is complete, it can be costly to pay off
your first mortgage and your home equity loan simultaneously.
4. Variable-rate
equity loans can put you at risk for negative amortization, in which interest
payments are too low to pay off the loan within its term.
Second Mortgage for a
Quick Boost
Second mortgages—subordinate
liens over a first mortgage—are most often used to raise cash for refinancing
or to bulk up a down payment on a first house at the time of purchase. They're
usually calculated at 75 to 80 percent of the home's appraised value and carry
a shorter 15-year term with fixed monthly payments. You can generally close on
a second mortgage within two or three weeks of applying.
Because they create
more risk for lenders, conditions for qualifying are stricter and interest
rates higher than for adjustable-rate home equity loans, conventional ARMs, or
fixed-rate first mortgages, but over time they're less costly than refinancing.
Separate closing costs usually apply.