Image courtesy of Flicrk, Ken Ratcliff
When is it the right time to refinance? We've turned to the pros to find out their best tips for refinancing your mortgage.
Many homeowners opt to refinance in order to obtain a better interest term and rate.
How does refinancing work? Essentially, the original loan is paid off, allowing the second loan to be created, instead of simply making a new mortgage and throwing out the original mortgage.
It may seem like a no-brainer to refinance if one has the option and this could be true for borrowers with a perfect credit history. However, borrowers with less than perfect, or even bad credit, or too much debt, refinancing can be risky.
So, how do you know if refinancing is right for you? Or, when is it the right time to refinance? We've turned to the pros to find out their best tips for refinancing your mortgage.
Most homeowners look to refinance in order to get a better rate on their mortgage, however, some argue that this may not be the deciding factor when it comes to refinancing.
''Contrary to popular belief, there are a few reasons ever to refinance and rate is NOT one of them,'' explains Greg Fischer, Vice President of Pinnacle Mortgage Corporation.
Fischer, a 12 year mortgage professional who has closed and counseled against many refinances, explains that there are four important factors that can help homeowners decide if refinancing is right for them:
1.Improve cash flow: By refinancing your mortgage, you may be able to save money each month and improve your cash flow. A lower rate can have a huge effect on monthly payments, potentially saving you thousands of dollars in a year. Oftentimes, this is done with a lower rate; however the rate is not the reason to do so.
Fischer urges homeowners should ask themselves: Are you saving money each month? How much? How long will it take to save more than the refi cost and will you be in the loan that long? ''It's a simple formula, but if you don't know your number, the rate is just a number,'' Fischer explains.
2. Access equity : This goes hand in hand with improving your cash flow.
Many people refinance in order to obtain money for large purchases such as cars or pay off debt. The way they do this is by refinancing for the purpose of
taking equity out of the home. First, the home is appraised. Second, the lender determines how much of a percentage of that appraisal they are willing to
loan. Finally, the balance owed on the original mortgage is subtracted.
3.Change in Loan Type: Other homeowners opt to refinance in order to change the type of loan.
''For example,'' Fischer explains, ''some homeowners opt to go from an adjustable rate into a fixed rate, or form a loan with PMI to one without. Other homeowners opt to change their loan terms from a 30 year to a 15 year.''
4.Change the ''Other'' Terms on your current mortgage: Others choose to refinance to change the terms of their loan. Perhaps you are removing a buyer from the current loan, such as divorce situation.
These four factors are huge advantages of refinancing your mortgage, however, Greg Fischer stresses that a lower interest rate should not be your sole deciding factor when looking to refinance.
When it comes to refinancing, the interest rate is important, but so are the points, fees and loan terms. Inspect the big picture to avoid making a big refinancing mistake.
Although refinancing may sound like a viable option, there are many risks associated with refinancing your mortgage that you should be aware of. One of the major risks of refinancing your home comes from the possible penalties you may incur as a result of paying down your existing mortgage with your line of home equity credit.
Additionally, there are fees that many homeowners are not aware of. These costs include paying for an attorney to ensure you are getting the best deal possible and handling paperwork you may not feel comfortable filling out, and bank fees. In fact, the up-front costs are extremely expensive, costing upward of $3,000 on average.
You'll have to weigh the amount of money you may be getting from your new line of credit against saving thousands of dollars in the long run.
Brian Davis, a real estate investor, co-founder and lead real estate blogger at SparkRental.com, strongly advises homeowners and long-term investors to get the right mortgage up front and avoid refinancing altogether if possible. ''This has been extremely easy for the last fifteen years with interest rates so low,'' Davis explains.
Davis also recommends avoiding refinancing for a very big reason: you start over on your amortization schedule.
'''Simple interest amortization' is actually not very simple,'' Davis continues. ''In the beginning of a loan, most of the monthly payment goes toward interest (even for low-interest loans). Gradually, a little bit more of the payment starts going toward principal, until you hit an exponential curve around two-thirds of the way through the loan term. But when you refinance, you start back at square one on your amortization schedule.''
It's in the bank's best interest to keep refinancing you, so that you never get far enough into your loan to really start paying down your balance. This is something that homeowners should be weary of when weighing out the pros and cons of refinancing their current mortgage.
Casey Fleming, author of The Loan Guide: How to Get the Best Possible Mortgage , says that his number one tip for refinancing is to not rely on a lenders payback analysis.
What is a payback analysis? A payback analysis ''is a comparison of the costs of doing the mortgage to the reduction in your monthly payment,'' explains Fleming. ''Almost all lenders will show a borrower a payback analysis to convince them to refinance. The trouble is, it is mathematically wrong, and can mislead folks into refinancing and spending more money as a result.''
The problem is that your mortgage payment isn't all cost. Instead, it's the cost (interest) and investment (principal). ''Only the interest portion is actually a cost to you. The principal portion is going to buy equity in your home,'' says Fleming.
Why is the payback analysis unreliable? ''When you refinance you usually add years to the life of your loan, and because you are starting the amortization cycle over again less of your payment on the new loan goes to principal, and more to interest,'' Fleming explains. ''Consequently, your principal balance goes down more slowly with the new loan, and when you sell or refinance again in a few years, you often owe more that you would have had you kept paying the original mortgage.''
So, what information can you rely on? Ask your mortgage advisor or loan officer to calculate the total cost of your proposed loan over whatever time you hope to hold the property. You can compare this to the cost of your existing loan, including paying off the principal balance at the target date. This should give you a better idea to see if refinancing is right for you.
Most banks and lenders will require borrowers to maintain their original mortgage for at least 12 months before they are able to refinance. It's important to note that each lender and their terms are different. Therefore, it is in the best interest of the borrower to check with the specific lender for details.
For your particular situation, it may make the most sense to refinance with the original lender, but it is not required. Your current lender may try to keep you by not requiring a new title search, property appraisal, etc.
If you are looking to refinance your mortgage, it's important to shop around for the best rate.
As a rule of thumb, Jeff Campbell from NewMiddleClassDad.com recommends refinancing when you can save at least ½ point on the interest rate and plan to stay in the house long enough to recoup those closing costs.
Compare hundreds of loans at once at BeSmartee.com to see if refinancing your mortgage is a viable option for you.
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