How Refinancing Works
Refinancing pays off existing mortgages, may also pay some or all closing costs, and can even return equity (cash out) to the owner of the property. The "Rule Of Thumb" used to be that if you could lower your interest rate by 2% or more then you should refinance; THAT RULE IS NO LONGER CORRECT! It may make sense for you to refinance even if you can lower your rate by only 1/2%.
Then again, you might be better off not refinancing if you plan to move in a year or two. It does make sense to refinance if you can recover your costs and make a fair return on your investment before you plan to sell your home or pay off your mortgage. We can help you calculate where your break-even point is on refinancing.
There are many reasons to refinance your home mortgage, but they all fall into three categories; you may want to use just one or all three:
- Save money with a lower interest rate.
- Use your equity to borrow more money.
- Restructure your existing mortgage.
Saving Money With A Lower Interest Rate
Refinancing to save money is like making an investment, where the interest you save is the return on your investment. You should ask yourself these questions before investing time and money in refinancing:
- How much will it cost me to refinance?
- How much money will I save?
- Are the savings large enough to justify the costs?
Remember these tips when refinancing to save money:
- Lowering your interest rate by as little as 1% can save you thousands of dollars ("no cost" refinances may make an immediate impact on your savings).
- You don't start saving money until after you have recovered the costs of refinancing.
- Look for a mortgage with few or no points, even if it has a slightly higher rate.
- Check your mortgage note for a "Prepayment Penalty Clause"; not all mortgages have them. This is a hidden cost of refinancing.
Use Your Equity To Borrow More Money
The equity that you have in your home is the value of your home minus the outstanding mortgage balance. You can borrow more money using your equity as collateral in a couple of ways:
- Replace your existing mortgage with a larger amount mortgage; or
- Leave your first mortgage in place and get a second mortgage.
There is no rule to tell you which of the above methods is best for you. The choice you make must be based on what you plan to do with the extra money, how much you'll need, and how quickly you plan to pay it off.
Remember These Tips When Using Your Equity:
- You can borrow more money by using the equity built up in your home as collateral.
- Compare the costs of a new first mortgage versus a second mortgage on large loans. Usually, a second mortgage will be cheaper up-front, even though it has a higher rate.
- On smaller loans, compare second mortgages, unsecured personal loans, and a line-of-credit mortgage.
Restructuring Your Existing Mortgage
Restructuring your existing mortgage financing is the final reason to refinance. Maybe you have a second mortgage coming due, or your current mortgage is an ARM (Adjustable-Rate Mortgage) and you want to replace it with a fixed-rate mortgage.
There are ARM loans with a "Convertible Feature" that allows you to convert your ARM loan to a fixed-rate mortgage after a period of time (and sometimes with a fee attached to it). If your existing loan has this feature, then we should review it with you to see if this is perhaps your best option.
Remember These Tips When Restructuring Your Existing Mortgage:
- When replacing a maturing second mortgage, be sure to compare the costs of a new second mortgage with the costs of replacing both your old first and second mortgages with a new first mortgage.
- Replacing an ARM with a fixed-rate mortgage will cost you money up-front, and may raise your monthly payments. But knowing your payment is fixed over the life of the loan could be well worth the costs.