Refinancing Your Home Mortgage
By Aaron Larson
- Initial Considerations
- Interest Rates
- Application Fees
- Closing Costs
- Charges for "Points"
- Duration of Residence
- Withdrawing Equity
- Shorter Mortgage Term?
- Refinance or Renegotiate?
When most people refinance their homes, they do so with the intention of obtaining a lower interest rate or reducing their monthly payment. The refinancing process involves taking out a new home mortgage, and paying off the existing mortgage with the proceeds of the new loan. While sometimes it seems like an easy decision to refinance a home, you should take care to ensure that your remortgaging decision is truly in your financial best interest.
Before you refinance, you should consider what else you might do with the money you will be applying to closing costs. Similarly, if you will be increasing your monthly payments to pay off your mortgage more quickly, what else might you do with the money that will go toward those increased payments? Sometimes you will get a better return by putting that money into a retirement account, money market account, or mutual fund than by refinancing your house.
You should also check to see if you are paying private mortgage insurance (PMI), and if you have enough equity in your home to cancel that insurance. The cost of PMI coverage can be substantial.
You should also check to see if you will have to pay a "prepayment penalty" if you refinance your mortgage. If you must pay a penalty, the size of the penalty will affect your determination of whether it is financially wise to refinance.
Perhaps the leading factor in most people's refinancing decisions is the prevailing interest rate. They understand that rates have dropped since they originally mortgaged their homes, and desire a lower interest rate and monthly payment.
Recall that mortgage closing costs and the change in your mortgage interest deduction must be factored into your refinancing decision. As a general rule, you will benefit from refinancing when interest rates have dropped two or more points since you obtained your original mortgage. But even if you are looking at a reduction of less than 2%, you may wish to explore the possibility of refinancing, particularly if you have built up equity in your home. You can easily shop around for the best rates, both online and by phone.
You may also wish to consider asking a lender to "lock in" an interest rate for a certain period, often forty-five to sixty days, in case interest rates rise. Any commitment to lock in the rate should be provided in writing.
If you pay an application fee when you apply for a loan or mortgage, find out up front if the fee is refundable if you are not approved for the loan or if you choose to use a different lender.
In addition to the application fee, when you apply for a home mortgage, significant costs will be incurred before the loan is closed, often including an appraisal, title fee, title insurance, survey fee, points, recording and transfer fees, and attorney fees. You should press your lender to provide as much detail about these costs and fees as you can possibly obtain, in advance of committing to a mortgage.
Even if you are promised a "no cost" refinance, you should keep in mind that costs are involved. You will pay those costs through an increased interest rate or higher loan balance. There's nothing wrong with considering a "no cost" deal, but you need to look carefully at what you will be paying - it may be that, even with costs, another loan package is cheaper.
Banks charge "points" when they issue loans to cover the cost of doing business. Generally speaking, the lower the interest rate for a loan the higher the number of "points" a bank will charge to issue the loan. Points are negotiable, and the number of points charged can vary between financial institutions. Borrowers are generally advised not to finance the points; and if you do intend to finance them you should consider how that will affect the financial benefits of refinancing.
To benefit from refinancing your mortgage, you should ordinarily anticipate staying within your home for at least three more years. If you intend to move before that time, the closing costs from refinancing are likely to subsume any savings from a lower interest rate.
If your home has appreciated since you bought it, when you refinance you may be tempted to get a larger mortgage and to pocket some of the equity in your home. You should check to see whether the use you have planned for the equity you withdraw is an "allowable expense" such that it qualifies for the mortgage interest deduction, and the significance of any change in your mortgage interest deduction.
When you refinance your home, you may wish to explore the possibility of obtaining a shorter mortgage term. Shortening the term could mean that, even if your payments don't change significantly, your home is paid off in fifteen or twenty years instead of thirty.
You should consider exploring the possibility of renegotiating your loan with your existing lender, instead of refinancing. Often the fees associated with a renegotiation will be significantly lower than those associated with refinancing, although the interest rates available are usually above what you would obtain if you refinance.
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