Should I Refinance?
Lowering your interest rate
The interest rates on mortgages are tied directly to how much you pay on
your mortgage each month, lower interest rates usually mean lower payments.
Lower interest rates may be available to you now because of any or all of
the following conditions - interest rate market is lower, better credit
scores, job situation, more equity in your house and/or better finances.
Adjusting the length of your mortgage
Increase the term of your mortgage:
You may want a mortgage with a longer term to reduce the amount that you pay
each month. This will however increase the length of time you'll be
making mortgage payments and the total amount that you end up paying toward
interest.
Decrease the term of your mortgage:
Shorter-term mortgages generally have lower interest rates. Plus, by
paying off the loan sooner, you'll be further reducing your total interest
costs. The trade-off is that your monthly payments are usually higher
because you're paying more of the principal each month.
Refinancing is not the only way to decrease the term of your mortgage.
By paying a little extra on principal each month, you'll pay off the loan
years sooner. For example, adding $50 each month to your principal
payment on a 30-year loan reduces the term by 3 years and saves you more
than $27,000 in interest costs.
Changing from an adjustable rate mortgage to a fixed rate mortgage
When you have an adjustable rate mortgage (ARM), your monthly payments
will change as the interest rate changes. With this kind of mortgage,
your payments can increase or decrease.
You may find yourself uncomfortable with the prospect that your mortgage
payments could go up. In this case, you may want to consider switching
to a fixed rate mortgage and give yourself some peace of mind by having a
steady interest rate. You might also prefer a fixed rate mortgage
(FRM) if you think interest rates will be increasing in the future.
If the monthly payment on a fixed rate loan includes taxes and insurance,
your payment each month will change over time due to changes in property
taxes, insurance.
Should you cash out your equity
Home equity is the difference between the balance you owe on your
mortgage and the value of your property. When you refinance for an
amount greater than you owe, you can receive the difference in a cash
payment otherwise known as a cash-out refinance. Remember though, when
you take out equity, you own less of your home. It will take years to
build your equity back up.
Many financial advisers caution against cash-out refinancing to pay down
unsecured debt (such as credit cards) or short-term secured debt (such as
car loans). You may want to talk with a trusted financial adviser before you
choose cash-out refinancing as a debt-consolidation plan.
Your current mortgage has a prepayment penalty
A prepayment penalty is a fee lenders might charge if you pay off your
mortgage loan early, including refinancing or selling your house.
You'll usually have a choice between a hard or soft if you choose a
prepayment penalty on your mortgage loan. A hard means you can't sell
or refinance your home without paying the penalty and soft means you can
sell your home without penalty, but if you choose to refinance you'll likely
pay a hefty penalty.
If you are refinancing with the same lender, ask them whether the
prepayment penalty can be waived, unlikely to happen but never hurts to ask.
You should always consider the costs of any prepayment penalty against the
savings you expect to gain from refinancing as it rarely makes sense to pay
the penalty. It is usually, but not always, better to wait until the
prepayment penalty falls off (ends after a pre-described time period).
Are you eligible to refinance?
Determining whether you're eligible for
refinancing is similar to the loan
process you went through to purchase your home. Your lender will
consider your credit score, debts, job status, income and assets, the
current value of the property and the amount you want to borrow.
Lenders will look at the amount your requesting and the value of your
home, determined from an appraisal. If the loan-to-value (LTV) ratio
does not fall within the lenders guidelines, they may not be willing to make
a loan.
If home prices have fallen in your area, your home may not be worth as
much as you owe on the mortgage. This is known as having negative
equity. If your mortgage loan includes negative amortization (your
monthly payment is less than the interest you owe, the unpaid interest is
added to the amount you owe), you may end up owing more than you originally
borrowed. If either of these scenarios happen, it can make it all but
impossible refinance.