Mortgage refinancing basics

Your mortgage may have a 30-year term, but not many homeowners stay with the same loan for that long. In fact, the average American refinances his or her mortgage every four years, according to the Mortgage Bankers Association. That’s because paying off your present mortgage and taking out a new one can mean big savings over several years. However, mortgage refinancing comes with a price in the short term, so it’s important to consider both the costs and benefits before making your decision.

Why refinance?
Here are some reasons to consider mortgage refinancing:

* To obtain a lower fixed rate. If you took out a fixed-rate mortgage several years ago and interest rates have since dropped, refinancing may lower your payments considerably. A $150,000 mortgage with a 30-year term and a rate of 8 percent, for example, carries a monthly payment of $1,100. The same mortgage at 6 percent will have a payment of less than $900 a month.
* To switch to a fixed rate or an adjustable rate mortgage. Adjustable-rate mortgages (ARMs) offer lower interest rates initially, but some homeowners find the fluctuations stressful. If rates are on the way up, you might consider locking in at a fixed rate and consistent monthly payment. On the other hand, if you want to reduce your monthly payments and are comfortable with the interest rate changes of an ARM, it could save you money to refinance to an ARM.
* To improve the features of your ARM. Mortgages with adjustable rates have protective caps that limit how much your payments can increase in any given year and over the full term of the loan. You may be dissatisfied with the caps on your current ARM and feel you can negotiate more favorable features if you refinance.
* To build your home equity faster. If a recent change in your financial situation has made it possible for you increase your monthly payments, you might want to refinance your mortgage with a shorter term. The higher payments will enable you to pay off your home more quickly and to save substantially on long-term interest charges. However, if you are disciplined you can also opt not to refinance and simply pay more towards your principal each month.
* To reduce your monthly payments. Refinancing for a longer term will lower the amount you have to pay each month. You will end up paying more in interest charges over the life of your loan, but if you’re having difficulty making your current payments, this strategy could provide some relief.
* To turn home equity into cash. You may want to take out a new mortgage with a larger principal, in order to turn some of your home equity into cash for a major expense. This is called cash-out refinancing. The advantage of taking out a loan secured by your home is that you can get a lower rate of interest than you can with an unsecured loan or credit card. However, if the interest rate offered for your refinanced mortgage is higher than your current rate, a home equity loan or line of credit might be a better choice.

Is mortgage refinancing right for you?
If you’re refinancing in order to pay less interest, you won’t usually see the savings right away. That’s because lenders typically charge fees when you take out a new mortgage, and you may also have to pay a penalty for getting out of your old one. To determine whether refinancing makes financial sense for you, consider these issues:

* How long you plan to be in your home. If you expect to move in a year or two, you may never realize the potential savings you’d get from refinancing. As a rule of thumb, the longer you plan to stay in your current home, the more sense it makes to refinance.
* The prepayment penalty on your current mortgage. Many mortgages carry a penalty if you pay them off early. The amount varies, but it is usually a small percentage of the outstanding balance, or several months’ worth of interest payments.
* The costs of the new mortgage. When you take out a new loan, your lender may charge a number of fees including application, appraisal, origination and insurance fees, plus title search, insurance and legal costs that can add up to thousands of dollars. Lenders may also charge discount points, which are paid upfront to secure a lower interest rate. As a guideline, expect fees to eat up any potential savings unless your new interest rate is at least a half a percentage point lower than your current one.
* The true difference in borrowing costs. When you’re considering refinancing, remember that the posted interest rate doesn’t reflect the entire cost of the mortgage. The amount you pay over the life of the loan will also be affected by the length of the term, whether your rate is adjustable or fixed, whether you paid discount points, and what upfront and ongoing fees you incur. One way to compare mortgage costs is to look at the annual percentage rate (APR), which takes into account not only the base interest rate, but also points and other charges. All lenders must follow the same rules when calculating the APR, so it’s a good basis for comparison.
* Your reduced tax savings. If you claim mortgage interest on your tax return, refinancing to a lower rate will mean that you’ll have less mortgage interest to deduct. You will still save money overall, but your real savings from refinancing may not be as large as you first believed. Consult a tax advisor who can help you understand the tax implications of refinancing.

The break-even point
In the end, deciding whether the cost of mortgage refinancing is worth it comes down to a simple question: “How long will it take before I start to save money?” In theory, this is a simple calculation. You start with the amount you will save by lowering your monthly payment. Then you add up all the costs associated with refinancing and divide the total by your monthly savings. This will reveal the number of months it will take to reach the break-even point.

For example, let’s assume that refinancing would lower your payment from $1,000 to $800 (for a savings of $200 per month) and your prepayment penalty, closing costs and points add up to $5,000. Divide $5,000 by $200 and you’ll see that it would take 25 months to realize the savings.

In reality, however, your break-even point also depends on other factors, including your tax situation and whether you pay closing costs upfront or add them to the principal of your new mortgage. If you are refinancing and your home has appreciated in value, you may also be able to save by canceling your private mortgage insurance.

For a more accurate estimate, use our refinancing calculator. Or consult a financial advisor who is familiar with your tax situation.

Source : LendingTree

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Cash-out mortgage refinancing

Your house is a potential source of money if you are willing to sacrifice some of your equity in return for liquidity. Cash-out mortgage refinancing is one way to access this cash.

What is cash-out mortgage refinancing?
Cash-out refinancing involves refinancing your mortgage for more than you currently owe and pocketing the difference. If you have been paying down your mortgage for some time, then the principal is likely to be substantially lower than what it was when you first took out your mortgage. That build-up of equity will allow you to take out a loan that covers what you currently owe -- and then some.

For example, say you owe $90,000 on a $180,000 house and want $30,000 to add a family room. You could refinance your mortgage for $120,000, and the bank will then hand over a check for the difference of $30,000.

You can take the difference and use it for home renovations, second-property purchases, tuition, debt repayment or anything else that needs a significant amount of cash. What’s more, you may be able to get a more favorable interest rate for your refinanced mortgage.

However, if the interest rate offered for your refinanced mortgage is significantly higher than your current rate, this may not be a sensible choice. A home equity loan or line of credit (HELOC) might be a better option in this instance.

Typically, homeowners are allowed to refinance up to 80 percent of their property’s value. Certain lenders may allow you to borrow more than 80 percent of your home’s value, but you may have to pay private mortgage insurance, or pay a higher interest rate.

Cash-out refinancing versus home equity loans
Homeowners sometimes confuse these two pools of home-financed cash. Cash-out refinancing and home equity loans are quite different. Cash-out refinancing is a replacement of your first mortgage; HELOCs are separate loans on top of your existing mortgage. In other words, with refinancing you get a new mortgage, not a second loan against the equity in your home.

Refinancing usually makes sense only when there has been a drop in interest rates and you want to lock in a new mortgage at a lower rate for a longer term than your existing mortgage. It can also benefit those who want to refinance their mortgages for a longer term to lower their monthly payments.

Source : Lendingtree.com

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Should you refinance your mortgage?

The average U.S. homeowner refinances his or her mortgage every four years. Sometimes it’s to take advantage of lower interest rates, but there are many other reasons to refinance. Are any of them right for you? Find out by seeing if you can answer “yes” to one or more of the following questions.

Are interest rates rising?
If you have an adjustable-rate mortgage (ARM) and expect interest rates to rise, you may want to switch to a fixed-rate loan. By locking in the interest rate, you won’t have to worry about your payments climbing in the future. On the other hand, if rates are rising and you have a fixed-rate mortgage, you’re in good shape. You may still have other reasons to refinance, but obtaining a lower rate isn’t one of them.

Is your monthly payment straining your budget?
You may want to consider refinancing to lower your monthly payment.
Even if rates are the same as when you obtained your current mortgage, you may want to refinance to extend the term of your loan if you’re having difficulty meeting your monthly payments. For example, assume you have a $200,000 mortgage at 6 percent for 30 years and have been paying $1,200 a month for seven years. Refinancing to a new 30-year loan at the same rate would lower your monthly payment to $1,075.

Is your ARM causing stress?
Perhaps you were attracted to an adjustable-rate mortgage because the initial rate and payments were lower than a fixed-rate loan. However, many ARMs are adjusted annually. That means if interest rates go up so too will your monthly payments. If you aren’t comfortable with this variance and would prefer the peace of mind of a consistent payment, consider refinancing to a fixed-rate loan or to another ARM with more favorable rate caps (limits on how much the interest rate can increase).

Has your credit rating improved?
When you applied for your mortgage, perhaps you had little credit history or maybe even a blemish or two on your borrowing record. Your credit score was a big factor when your lender determined the interest rate on your mortgage. If you had a low or mediocre score that has since improved, you may now be eligible for a better rate if you refinance.

Have you recently begun to earn a higher income?
Refinancing isn’t always about lowering your monthly payment. Maybe you’ve received a salary increase at work, or your spouse has recently returned to the workforce after staying home to raise a family. You may want to put that extra income towards your mortgage. Converting to a 15- instead of a 30-year amortization, for example, will pay it off much faster and save you tens of thousands of dollars in interest payments.

Has your home equity climbed above 20 percent?
If you obtained your mortgage with a down payment of less than 20 percent, chances are you incurred Private Mortgage Insurance. However, if rising house prices have increased the value of your house, your home equity may now exceed 20 percent. If this is the case, you have several options. First, you can ask your lender to cancel your PMI. To do this, you’ll need to get an appraisal to prove that your home’s value has increased and that you have exceeded 20 percent equity. However, if you can’t persuade your lender to drop the mortgage insurance, you might want to consider the refinancing. If your new mortgage is for at least 80 percent of your home’s appraised value, you’ll avoid paying PMI and could save $100 a month or more.

Do you need to consolidate debt?
If you have built up considerable equity in your home, but you’re mired in other debt, consider cash-out refinancing. That involves getting a new mortgage for a larger amount than you currently owe. For example, if your home is worth $285,000 and your outstanding principal is currently at $185,000, you have $100,000 in equity. By refinancing to a new mortgage with a principal of $215,000, you can free up $30,000 to pay down high-interest credit card or other debt. You’ll save money if your new mortgage has a lower rate than the other loans, and you’ll have the added convenience of only having to make a single monthly payment.

Do you need money for a major expense?
Cash-out refinancing isn’t just for consolidating debt. If you have available equity in your home, it may enable you to undertake some major home improvements, or to free up money for your children’s education. If you do plan on taking cash-out, it's important to be realistic about your future goals. Remember that taking cash out will increase the principal you owe on your home. This may impact you when you go to sell your home.

Remember, refinancing doesn’t come without a price: closing costs will eat into your savings at first, so the longer you plan to stay in your home, the more you’ll benefit. Before considering refinancing, use the LendingTree refinance calculator to help determine your break-even point.

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