There are lots of benefits to refinancing your home if you understand
the terms of the loan and know a little bit about your future financial
outlook. Simply put, refinancing is adjusting the terms of your mortgage. You
can adjust your mortgage to pay more per month so that the life of your loan is
shortened. Or you can adjust your mortgage to pay less per month so that the
life of your loan is lengthened. Both can be advantageous if used properly, and
both can be hazardous if used recklessly. This article is designed to give you
the information you need in order to make the decision about what's best for
your financial future.
Know what will
influence the rate that you will receive. Here are the elements that will determine the rate you
will receive:
Loan size
Your credit score
Paid points
When is the closure of the loan?
Locked or floating rate
Debt to income ratio
Understand that advertised rates are not reliable. Experts say that when mortgage refinancing companies publish their rates, it is most likely that only about 10% of applicants get to use them. The displayed low rates are used to lure people. It's not always wise to fall for them.
Know the costs
associated with refinancing. It probably doesn't make sense to refinance if the
costs and fees associated with refinancing are bigger than the amount of money
you would have saved after refinancing. Figure out up front how much you're
likely to be charged for refinancing. It is not uncommon to pay between 3% and 6%
of your principal in fees. Some
possible fees you could face include:
Application fee: $100 - $300
Appraisal fee: $300 - $700
Loan Origination fee: up to 1.5% of the loan principal
Points: up to 3% of the loan principal. One point is equal
to 1% of the total mortgage amount.
Inspection fee, Attorney Review fee, Survey fee, and Title
Search and Insurance fee:
$1,500 - $2,500
$1,500 - $2,500
Find out whether
your lender has a prepayment fee associated with your current mortgage. Some lenders will charge you a one-time fee if you
decide to pay off your existing mortgage early. Why is that? Because the lender
stands to lose a certain amount of money if they can't make extra money off of
interest payments.
Know, however, that some states have banned prepayment fees.
Mortgages insured or guaranteed by the federal government, as well as loans
insured by federal credit unions, are also barred from levying prepayment fees.
How much can you expect to pay if you encounter a prepayment
fee? Prepayment fees generally weigh in at one to six months' worth of interest
payments.
Lengthen the term of your mortgage to reduce your monthly payments. If you desire smaller monthly payments on your mortgage, consider lengthening the term of your mortgage. Expect to pay more money (primarily in interest payments) over the course of your mortgage. Know, too, that you'll make payments for a longer period of time. This isn't always the most prudent move, but for many people, it's the difference between holding onto their home and giving it up.
Say your existing mortgage is for $200,000 on a 30-year
fixed at 6%. After three years, you get the option to refinance at 32 years and
6%. You'll be paying $134 less per month, but the total cost of the mortgage
will rise to $111,791 over the life of the loan.
Shorten the term of
your mortgage to reduce the total interest paid. People who shorten the terms their loans spend less
time paying off their mortgage. The tradeoff is that their monthly payments
increase. At the same time, because they're trading in a longer mortgage for a
shorter one, they spend less on interest payments in the long run.
Say your existing mortgage is for $200,000 on a 30-year
fixed at 6%. After three years, you get the option to refinance at 15 years and
5%. You'll be paying $319 more per month, but you'll ultimately be saving a whopping
$109,211 over the life of the loan. If you can manage the extra $319 per month,
it's definitely worth refinancing.
When deciding whether to lengthen or shorten the term of your mortgage, balance out your short-term needs with your long-term needs. Refinancing your mortgage is a serious financial undertaking. Whether you want to lengthen or shorten the term of your mortgage, it's a good idea to investigate why, taking both your short- and long-term needs into consideration:
For example, if you're lengthening the term in order to pay
$100 less monthly, but you'll pay $100,000 more over the life of the loan,
you're literally mortgaging your future in order to bankroll the present. See
if you can't rummage up the extra $100 a month in order to save you a fortune
over the long term.
Similarly, what if you're moving from a 30-year fixed to a
15-year fixed because you want to save money in the long run? If you can't
afford the $300 per month, and this uptick puts you into debt, you may want to
hold off refinancing until you can actually afford the change.
Know that the monthly payments of ARMs can shift according to
interest rates.ARMs' monthly payments are tied to interest rates.
Some months, you might get a very decent monthly payment because interest rates
have gone down. Other months, you might get a bigger-than expected monthly
payment because interest rates have gone up.
Beware the teaser rate on option ARMs. Many ARMs will feature a special "teaser rate" that advertises a lower-than-average initial interest payment on the loan. Often, this rate lasts for just a year or even several months, after which the interest payments skyrocket.
These loans often seem too good to pass up. Remember, if
something seems too good to be true, it probably is. Always read the fine print
associated with a loan, but especially those loans which appear to give you the
deal of the century.
If refinancing from one ARM to another ARM, look at the
initial rate as well as any payment caps. If you are refinancing, look for another ARM with a
lower initial rate, so your interest payments start off less. Also look for
deals when it comes to payment caps. Payment caps are the total increased
amount you can pay from month to month. If your ARM has a payment cap of 6%,
then the total increase you can pay from one month to the next is 6%, even if
interest rates increase more than that.
Consider not refinancing
when you've invested in your current mortgage for a long period of time. The longer you make payments on a mortgage, the more
equity you build up in your home. Equity is just a fancy name for how much of
the home you actually own, or how much of the principal on your home you've
paid off. The amount of money you pay towards your principal counts toward
equity in your home, while the amount of money you pay towards interest does
not.
When you begin make mortgage payments, most of your money
goes toward interest payments, not principal. In the beginning, you haven't
built up much equity. After the 20-year mark or so on a traditional 30-year
fixed, you start to pay off more and more principal in your mortgage and less
interest. This means your stake of equity in your home grows.
Refinancing after you've held onto the same mortgage for a
long time restarts this amortization process. You spend the early years paying
off interest instead of building equity in your home by paying off principal.
Consider not refinancing
if you plan to move soon. If you plan on moving sooner rather than later, the
costs of refinancing may not make economic sense. Think about it: You're
spending upwards of $5,000 for a new mortgage on your existing house, when
you'll probably need to spend the same amount on a new mortgage for a new
house.
Look at break-even calculators online to examine whether it
makes sense to refi if you expect to move soon. Simply type in "refinance
calculator break even" into a search engine.
Consider not refinancing if you
have to pay a significant prepayment fee. You may be levied with a prepayment fee if you break off
your existing mortgage prematurely. If, however, you plan on refinancing with
the same lender, ask them if they can waive the fee. In rare cases, lenders
will waive the fee. When prepayment fees become
excessively costly — sometimes up to 6 months' worth of interest payments —
consider waiting for a better time to refinance.
Factor in certain
eligibility requirements. Lenders will look at a whole host of things in order to decide whether
they're willing to give you the loan at your terms. Lenders will factor in your
income and other assets, your credit score, the current value of the home, as
well as the amount you wish to borrow. Primarily, lenders will look at the loan
to value ratio (LTV) — that is, how much you're asking compared to the value of
the home. If it doesn't fall within their acceptable range, they might not
offer you the mortgage you're looking for.
Credit score has a
huge impact on the terms of your refi. If your credit score went up after you
agreed on your current mortgage, lenders will be likelier to offer better
terms. If your credit score went down after you agreed on your current
mortgage, lenders may offer only higher interest rates.
Know what type of
loan you want.
Disclosing
details to the loan officer should help you get the best possible rate. State
how long you'd like your mortgage to last, as well as how much you really need
for the house. Disclose also whether you're willing to pay points in order to
lower the interest rate.
Note: if you're serious about staying debt-free, don't
exaggerate how much money you need and then pocket the difference between the
loan and the value of the house. While some mortgage loans can be advantageous,
others are not. You might get a loan with better terms by shopping around a
credit union or going to your local bank. Using a second mortgage as a source
of cash is a sure way to lose money in the long run.
Ask about "no-cost" refinancing.
No-cost refinancing is basically where the lender
assumes the cost of up-front fees (origination fees, application fees,
appraisal fees, survey fees, etc.) in exchange for a higher interest rate.
While these may be viable options for people who want to refinance but cannot
afford the up-front fees, they should be avoided, if possible, by those who can
afford the out-of-pocket fees. Why? Because the interest tacked on to the life
of the loan is often more than the out-of-pocket fees the homeowner would have
originally paid.
Shop around. This is one of the
best ways to go with any kind of transaction. Know the credibility of your
choice lenders. Don't be afraid to try to get better terms from different
lenders. You're most likely going to be entering into a 30-year contract; you
should trust the lenders and feel like you're getting the best bang for your
buck.
Allow ample time for you to get the hang of all the mortgage terms if you're a newbie on this industry. Doing your homework will save you not just some money but also future headaches.
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