Deciding whether and when to refinance can be a puzzling task. For starters, many of the rules of thumb about when and how to do it have become outdated. A couple of calculations now serve as a better guidepost. First, add up how much you would pay in closing costs, fees and points on a new loan. Then figure out how much your monthly payment will drop. Savings depend on the size of your loan and interest rate. By dividing the monthly savings into the total cost, you can determine how long it will take for the transaction to pay off. Then ask yourself the question: How much longer will I keep this home? The savings you realize in the form of a lower monthly mortgage payment spread over the amount of time you expect to remain in the home should justify the cost of refinancing.
Remember that when you refinance, you may have to pay many of the same costs associated with the first mortgage you obtained. Because you are applying for a new mortgage loan, you may have a fee for a new credit report, title search and closing fees, the cost of a new appraisal, a loan origination fee and whatever points your lender charges for a new loan.
Today, many lenders offer zero point/zero cost refinances that provide a way to reduce the cost associated with the refinance of a mortgage loan. Points and customary closing costs can be financed up to the limit of the loan-to-value ratio permitted under refinance transactions. This is generally 90% of the property value when you refinance to reduce interest rate only and 75% of the property value when you remove equity from the property (receive cash).
Depending on your financial goals and needs, a lower interest rate with high points means a lower monthly payment but a higher cost at loan closing. Each "point" is equal to one percent of the loan amount and represents interest you pay up front. If you want to keep the cost of origination down, and do not mind a larger monthly payment, you may want to look for a slightly higher interest rate with fewer points to help to reduce or eliminate the cost of refinancing
Some of the costs in a mortgage transaction are deductible, but the guidelines are different for refinances and purchases. Points paid on a refinance transaction must be deducted in equal yearly amounts over the life of the loan and not in one lump sum. State and local tax laws vary with each state or jurisdiction. Homeowners should check with their tax advisor or the IRS if they have questions.
If you plan to remove equity from your home, that is, to receive cash from a refinance transaction, you must have a certain amount of equity remaining after the new mortgage is issued (usually about 25%). If the value of your property has declined, you may not be able to take cash out, but may still benefit by refinancing to reduce your interest rate.
If one of the reasons you are considering refinancing is to obtain cash to improve your present home it may be wise to consider resale since not every improvement will pay off when your house is sold. According to a survey of real estate experts in Remodeling magazine, full second baths, insulation, re-roofing, new siding and new kitchens return about 60% of their cost, while pools and sun rooms rarely return half their expense. As an informed purchaser you may be able to find a dream home with a recently remodeled kitchen, that extra bath or new roof, at a cost 40% less than had you done it yourself. When mortgage rates are low your ability to trade up improves. This also means that the number of qualified potential purchasers for your present home will be greater.
For both present home owners and first-time home buyers the length of time you expect to own the home, your financial goals, and the amount of monthly payment you can comfortably afford are questions to be answered to help in selecting the best mortgage option. Today, the time tested 30-year fixed rate mortgage continues to be the most popular mortgage option since it offers a fixed payment for the life of the loan. Those that have a goal of faster equity accumulation or free and clear ownership may wish to consider a shorter term 10-year, 15-year, or 20-year, fixed rate loan. In exchange for a slightly higher payment these shorter terms loans will reduce the total interest paid during the life of the loan while building up equity much faster.
For those who plan to move within the next several years (10 years or less) there are a number of adjustable rate mortgage loans that might be considered. Changes in your monthly payment on these loans range from those that adjust annually to those that are fixed for a period of 3, 5 or 7 years and then adjust annually thereafter. The advantage of these loan types is that they typically offer a lower interest rate than fixed rate mortgages and hence a lower monthly payment.
There is no limit to how many times you can refinance your home, but if you have a new loan, some lenders and investors require that you have a good payment history for the previous 12 months before they make a new loan.
When you refinance, you pay off an existing mortgage and take out a new one. To do this, you usually repeat the entire process of applying for a mortgage loan. This includes completing an application, qualifying for credit, paying points, getting a new appriasal and paying closing costs.
Because you are applying for a new mortgage loan when you refinance, you need much of the same documentation that was required when you first bought the home. This includes verification of income, a list of your current debts and assets, account numbers and balances for your savings, checking and investment accounts. Your current mortgage servicer (the lender to whom you make your mortgage payment) or the company from which you originally received your financing may be helpful in making recommendations on ways to reduce documentation and expedite your processing.
When considering placing an application with a lender for a refinance it may be advisable to ask whether there is any special consideration with regard to costs, interest reate or documentation requirements if you return to refinance in the future.
If you are refinancing only to reduce your interest rate and have not used your equity line of credit during the previous 12 months, you can combine your first mortgage with the balance on a home equity line of credit, eliminate the home equity loan, and have just one primary mortgage. The maximum amount of your new mortgage generally cannot exceed 90 percent of the value of your home. (This is called a 90 percent loan-to-value ratio).
If you were fortunate to finance a new home or refinance your existing mortgage during the periods of low rates, it may not be possible to lower your mortgage interest rate at this time. However, there are many who would benefit from the refinance of an existing mortgage to consolidate higher interest rate non-deductible debt into a new first mortgage. While your motgage rate may not decline (or even increase slightly) you may be able to achieve a significant reduction in your monthly obligations - not to mention the tax advantage of the deductible mortgage interest. Also, a refinance can free up equity in your home for other purposes such as home improvement, college tuition, a special purchase or much needed vacation.
If you still can not bear the thought of giving up that low interest rate mortgage you may wish to consider a home equity loan. While rates on a home equity loan are higher than mortgage rates, they can be a good way to tap equity in your residence without paying off your existing mortgage.