Is It Time to Refinance Your Mortgage?
Refinancing is the process of paying off an existing loan with the proceeds from a new loan, and using the same property as collateral. Usually, the interest rate on the new mortgage will be less than the old, the loan will cost less and you will save money. However, refinancing isn’t appropriate for every homeowner. To know if it’s right for you, understand how these arrangements work.
Many people choose to refinance because the reduced interest rate decreases their monthly mortgage payment, freeing up cash for other expenses. Every percentage point makes a difference. For example, if you refinanced a $200,000, seven-percent interest loan to a loan with six-percent interest, you’d have about $130 more in your pocket each month.
Another reason to refinance is to repay your mortgage faster, which is done by switching a long-term loan for one with a shorter term. With it, your mortgage payment would be higher, but you’d pay much less in interest over the life of the loan while building equity more quickly.
Cash-out refinancing is yet another attractive option. With this type of loan you’d refinance your current mortgage plus take out some cash from the equity you’ve built up. The benefit? Interest rates on the cashed-out portion are often lower than a home equity line of credit, home equity loan, or second mortgage.
To determine if refinancing will work in your favor, you’ve got to weigh the savings in interest against the fees associated with refinancing. A new loan means you’ll have to pay most of the same costs you paid the first time around. These may include points, appraisals, attorney’s fees (in Attorney states), settlement costs (such as fees for the loan application, title search, appraisal, loan origination, and credit check), recording fees or transfer taxes, and sometimes a pre-penalty penalty. All totaled, these costs can be high, and some lenders require at least a portion of them be paid at the time of application.
Much of the loan’s price depends on points. One point equals one percent of a loan, and to get you the lowest rate, most lenders will charge several points. The total cost can run between three to six percent of the whole amount you borrow. Therefore, on a $100,000 mortgage, the lender might charge between $3,000 and $6,000.
Some lenders do offer zero points, but the loan will have a higher interest rate. So while a “no points loan” may indeed reduce your initial outlay, your monthly payment will be higher.
To know what combination of rate and points is best for you, compare the amount you can pay up front with the amount you can pay monthly. The less time you keep the loan, the more expensive points (and other refinancing costs) become. For example, if your refinancing costs are $3,000 and your payments are $125 lower each month, it will take you 24 months just to break even.
The tax effect
One of the primary advantages of homeownership is the savings you receive on your income taxes—all that interest (up to a million dollars for the first loan, and $100,00 for the second) is tax deductible, after all. Yet if you refinance the loan with a lower interest rate, you’ll have less interest to deduct. The effect may increase your tax payments and decrease the total savings you might obtain from a new, lower-interest mortgage.
If, however, you are in the final years of your mortgage, your payments probably consist of more principal and less interest. In that case, refinancing your mortgage with a longer-term loan will mean you’ll again pay more in interest—and increase your tax deduction.
The best deal
So where do you find the best refinancing deal? The best arrangement may be with your current lender, since some offer original mortgage customers the lowest rates and cut-rate closing costs. Before deciding, though, shop around by calling several lending institutions and ask each one what interest and fees they charge. If you have Internet access, research rates before speaking to a lender, so you’ll be armed with the knowledge of what is out there.
If the idea of refinancing fills you with as much fear as it does excitement, you have reason. This is a major financial decision, and one not to be taken lightly. Thankfully, some powerful consumer laws protect you against lending abuses.
When you refinance, your lender must provide a written statement (the Loan Estimate) of the costs and terms of the financing before you become legally obligated for the loan. Review this statement carefully. If you refinance with a different lender, or if you borrow beyond your unpaid balance with your current lender, you also must be given the right to cancel within three business days following settlement, receipt of your disclosures, or receipt of your cancellation notice, whichever occurs last.
If your lender charges an application processing fee, ask how much it is and under what circumstances it is refundable. Some lenders do not offer refunds if you are not approved for the loan or if you decide against taking it.
So is it time to refinance your mortgage? If you will come out ahead financially, then it is definitely worth considering. However, if the difference is minimal or nil, then save yourself the time and trouble. Refinancing is not the magic answer for everyone.
Revised January 2016