Refinancing your home can reduce your monthly mortgage payment, raise cash, or consolidate high-interest debt. Before you refinance however, do your homework to factor in the difference between current interest rates and the rate of your original loan and account for the amount of time it will take to recoup refinancing costs.
Homeowners typically refinance to:
- Lower monthly mortgage payments
- Convert an adjustable rate mortgage (ARM) to a fixed-rate mortgage
- Raise funds for expenses (home improvement, medical bills or college tuition)
- Pay off high-interest loans
The old rule of thumb is, refinance if rates fall more than 2 points below your existing rate, because refinancing involves closing costs (loan origination fee, prepaid interest, etc.) For anything less than 2 percent, the savings on your monthly mortgage payment might not be significant enough to offset the closing costs.
Savings vs. Time
For some homeowners though, the rate isn't as important as the time needed to break even on the refinancing. If refinancing costs are $3,000 and the monthly payment is only lowered by $90, it would take almost 3 years for the savings to cover the costs.
If your existing loan information (survey, title search, etc.) is still current, the lender may waive many of the fees. You may also be able to roll the closing costs into the new note. In other words, you don't avoid the closing costs, but instead pay them back over time along with the rest of the loan. But be sure to calculate the potential savings vs. the expense of paying off a higher principal balance.
Refinancing usually lengthens the amount of time it takes to pay off your home. If you are 3 years into a 30-year mortgage and refinance with a new 30-year loan, you'll end up making payment for 33 years but if the monthly savings are substantial enough, you still could pay much less over the long haul.
Adjustable Rate Mortgages (ARMs)
Rising interest rates might influence you to covert your ARM into a fixed-rate loan if you plan to own your home for several more years. Or, you may plan to movie in a year or two, and find an ARM option with dramatic interest rate savings. In either case (as long as closing costs are minimal), it might make sense to switch.
Refinancing doesn't mean giving up all the money you've paid towards your existing mortgage. With each payment, you've built equity (the amount paid on the principal balance) A $100,000 loan at 8%, would build about $2,800 worth of equity in the first 3 years. After refinancing, the new loan would only amount to $97,200.
Raising cash with home equity loans... use caution
With enough equity, you can refinance in order to take cash out of the property to pay off credit cards, add a new bathroom, or cover the cost of braces. Lenders will typically allow you to borrow against the equity you've built in your home, plus appreciation. Use caution and do your research as rates can be significantly higher with loans offering appreciation of 100% or more and any amount borrowed about market value is NOT tax deductible.
Talk to your lender
As with any important financial decision, take time to shop around and speak with several lenders before deciding. Be sure to discuss all the expenses and benefits, as well as what will be expected of you, in advance. The more you educate yourself, the better your chances of finding the right refinancing package.
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